DIPLOMARBEIT

bdquo The German Retail Banking Market

Business Models and Entry Mode Choice of Multinational

Angestrebter

Magister der Sozial

Wien im Juli 2010

Studienkennzahl lt Studienblatt 157Studienrichtung lt Studienblatt Internationale BetriebswirtschaftBetreuerBetreuerin Univ-Prof Dr Windsperger

DIPLOMARBEIT

Titel der Diplomarbeit

German Retail Banking Market

Business Models and Entry Mode Choice of Multinational Banksldquo

Verfasser

Timm Rufo

Angestrebter akademischer Grad

Magister der Sozial- und Wirtschaftswissenschaften

(Mag rer soc oec)

Internationale Betriebswirtschaft Windsperger

German Retail Banking Market -

Business Models and Entry Mode Choice of Multinational

und Wirtschaftswissenschaften

II

Eidesstattliche Erklaumlrung

Hiermit erklaumlre ich von Eides Statt die vorliegende Arbeit eigenstaumlndig und nur unter

Verwendung der angegebenen Hilfsmittel angefertigt zu haben

Die aus fremden Quellen direkt oder indirekt gewonnenen Gedanken sind als solche

kenntlich gemacht

Die Arbeit wurde bisher in gleicher oder aumlhnlicher Form keiner Pruumlfungsbehoumlrde

vorgelegt und auch noch nicht veroumlffentlicht

Wien im Juli 2010

Timm Rufo

III

IV

Acknowledgements

Foremost I thank my parents for supporting and encouraging me to pursue this degree

Moreover I would like to thank my brother Marc for his direction and assistance In

particular Marc`s recommendations and suggestions have been invaluable for my

studies and this thesis

In addition I would like to thank Professor Josef Windsperger who provided scientific

support to make this work possible

I would also like to thank Bennett Schwartz Director of International Banking at TD

Bank who gave me the opportunity to work in his department and sparked my interest

in the theme of this thesis

Last but not least special thanks should be given to my student colleagues who helped

me in many ways In particular I thank Urszula Gudacz who has been an exceptional

friend and a great support during my years of study

V

VI

Table of contents

List of Figures VIII

List of Abbreviations IX

1 Introduction 1

11 Research Objective 2

12 Structure 2

2 Classification of Banks 5

21 Bank 5

22 Direct Bank 5

23 Brick and Mortar Bank 6

24 Multinational Bank 6

25 Retail Bank 6

3 Market Entry Theories and Strategies 7

31 Transaction Costs Theory 7

32 Eclectic Theory 8

33 Strategy of Defensive Expansion 10

34 Strategy of Offensive Expansion 11

4 Structure Analysis German Retail Banking Market 12

41 Porter`s Five Forces 12

42 Rivalry Among Existing Competitors 14

43 Threats of New Entrants 23

44 Threats of Substitutes 25

45 Bargaining Power of Suppliers 26

46 Bargaining Power of Buyers 27

5 Foreign Bank Entry Strategies in Germany 28

51 Cross-border lending 30

52 Alliances 31

VII

53 Joint Ventures 32

54 Representations 33

55 Entry Mode Choice Greenfield-Branch vs Acquisition-Subsidiary 34

56 Business Model Choice Direct Bank vs Brick and Mortar Bank 38

561 Demographical Trends 40

562 Technological Trends 42

6 Case Study ING DiBa 45

61 Corporate Profile ING Group 45

62 Market Entry and Market Penetration 45

63 SWOT Analysis 46

64 ING DiBa SWOT Analysis 48

641 Strengths 48

642 Weaknesses 48

643 Opportunities 49

644 Threats 49

65 The Service Marketing Mix 50

66 ING DiBa Marketing Mix (7Ps) 52

67 Summary 55

7 Conclusion 56

Literature

Appendix

VIII

List of Figures

Figure 1 Classification of retail banking clients 6

Figure 2 Michael E Porter`s Five Forces model 12

Figure 3 Structure of the German banking sector 15

Figure 4 Customers of German banks at the end of 2007 (in millions) 16

Figure 5 Estimated development of the German population (in millions) 19

Figure 6 Development of total bank branches in Germany 20

Figure 7 Market share development of accounts that mature daily 21

Figure 8 Market share development of consumer loans 22

Figure 9 Comparison of former and modern retail banking customers 27

Figure 10 A hierarchical model of entry mode choices for banks 28

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks 30

Figure 12 Development of foreign MNBs branches in Germany 35

Figure 13 Development of foreign MNBs subsidiaries in Germany 37

Figure 14 SWOT analysis 47

Figure 15 Service Marketing Mix 51

IX

List of abbreviations

ATM Automated Teller Machine

BampM Brick and Mortar

CEE Central and Easter European

EEA European Economic Area

FDI Foreign Direct Investment

GBA German Banking Act

ICT Information and Communication Technology

JV Joint Venture

MNB Multinational Bank

MNE Multinational Enterprise

RDC Remote Deposit Capture

SMEs Small and Medium Sized Enterprises

TCE Transaction Costs Economics

WOS Wholly Owned Subsidiary

ZEW Centre for European Economic Research

1 Introduction

In the aftermath of the recent financial crisis1 and in times in which banks

rediscover the private individual ndash also described as the renaissance of retail

banking2 - significant attention is now being paid to the market entries of foreign

multinational banks3

The German retail banking market is highly competitive Private cooperative and

state-controlled savings banks compete intensely for market share with hardly any

cooperative activities among the groups As savings banks are owned by German

states towns or local authorities they are protected by law from takeovers by

institutes from the other banking sectors4 Due to the high fragmentation of the

German market hardly any bank has dominant market power The five largest

banks have a total market share of only 20 percent and new competitors enter the

market and attract customers with aggressive price differentiation offers5 The

strong competition among private banks savings banks and co-operative banks

results in low profit margins by international comparison The profit potential in

German private-customer business has fallen for many years From 2000 to 2006

total income from the financial service providers in Germany measured by the

distribution of financial products with private customers fell approximately 15

from euro 675 billion to euro 574 billion6 Though the retail banking sector has

experienced some increase in profits due to cost reduction and reduced loan

failures in 2007 market potential still stagnated in 20097

Since the financial crisis has raised the awareness of the threats of investment

banking many banks have refocused on core business activities in order to

maintain their solvency through increased account deposits Banks need money to

grant loans to private individuals or enterprises provide investment opportunities

finance consumer goods or simply realize baking transactions Yet the recent

financial crisis caused distrust among the banks and loans will not be granted as

1 Plickert (2009) 2 Deutsche Bank (2009) 3 Koumlhler and Lang (2008) 4 Spiegel Online (2007) 5 Welp (2009) 6 Zebrolfesschierenbeckaccosiates (2008) 7 McKinsey amp Company (2007) Zebrolfesschierenbeckaccosiates (2008)

2

easily as before On the consumer side the financial crisis has increased the

demand for secure money investments A survey of 230 highly ranked managers

from private savings and co-operative banks on the effects of the crisis on their

business indicates that banks have concentrated more intensively on business with

private customers both during and after the latest crisis Moreover customer

demand for certificates company shares or funds has fallen significantly while the

demand for standard retail banking products such as call money accounts or

account books has increased substantially8

In spite of its high competitiveness and low profit margins the German retail

banking market is still attractive for foreign banks Foreign MNBs are increasingly

able to penetrate the market for private individuals9 In particular they gain market

share through new products decreasing prices standardized processes and

innovative marketing whereas domestic banks have often relied on continued

customer loyalty10 Although foreign multinational banks in Germany have usually

concentrated on large domestic corporations engaged in international

transactions11 they now enter the market for private and small corporate clients as

well12- a trend that has been supported by the development of internet technology

and other new marketing - channel options

The distinctive characteristics of the German banking market raise several

questions concerning both entry mode and business model considerations of

multinational banks Should a multinational bank engage in cross-border lending or

rather enter the market via foreign direct investment How do the development of

economic political-legal and social-cultural factors in the German market affect a

multinational bank`s entry mode and business model choice

This thesis distinguishes between the non - equity entry modes of cross-border

lending and alliances as well as the equity entry modes of representative offices

branches subsidiaries and JVs both from a Greenfield investment and an

acquisition point of view Each of these organizational entry mode forms has

8 Welp (2009) 9 Reitz (2005) 10 McKinsey amp Company (2007) 11 Hersh and Weller (2002) 12 Koumlhler (2008)

3

distinctive advantages and disadvantages Hence the main focus of this thesis is to

provide a broad understanding of the distinctive market entry and penetration

strategies in light of macro and micro economical developments in Germany

11 Research Objective

This thesis examines entry mode choice decisions and business model

considerations of multinational banks entering the German retail banking sector

The objective is to evaluate the affect of current market developments on their

entry mode decisions

In light of the financial crisis and the banks` rediscovery of the private individual

the German banking sector is currently experiencing a renaissance resulting in

increasing industry rivalry At the same time the processing of bank transactions

and customer services is becoming increasingly independent of the branch

distribution channel and the adoption of new technologies is substantially affecting

the allocation of retail banking services13 The technological evolution is

exemplified by the emergence of web-based direct banks which have been able to

penetrate the retail banking market with low-cost structures innovative ideas and

distinctive service thinking

Eventually the growing importance of the internet and other technological means

as distribution channels on the one hand and the remaining strong demand for

personal consultation on the other hand require a customer-oriented multi-channel

management of the banks14

This paper contrasts the two opposing ends in the field of retail banking

distribution channels It simplifies the entry mode choice between direct banks that

solely operate through the internet and brick amp mortar banks which solely operate

through a branch network Furthermore it differentiates between branch entry via

Greenfield investment and subsidiary entry via acquisition

Two major questions will be addressed

13 Deloitte (2010) 14 Welp (2009)

4

Firstly to what extent do demographic and technical developments favor a direct

bank entry mode over a brick and mortar bank approach in Germany

Secondly what affects the decision in favor of a branch entry mode via Greenfield

investment as compared to a subsidiary entry mode via acquisition in Germany

12 Structure

This thesis is systematically divided into two different complexes - a theoretical

and a practical After a classification of essential banking terms in the section 2

Section 3 then describes relevant market entry theories ndash namely the Transaction

Costs Theory and the Eclectic Theory as well as market entry strategies ndash namely

the offensive and the defensive strategies of expansion

In section 4 the German retail banking market is analyzed within the five forces

framework The goal of this examination is to evaluate market attractiveness and to

identify micro and macroeconomic developments that may shape the market in the

future

Given the theoretical framework of section 3 and the knowledge of industry

structure and trends of section 4 section 5 explores the decision driving factors of

entry mode choice In this section cross-border lending alliances joint ventures

and representations will be discussed Furthermore this section indicates what

affects the decision in favor of a branch entry mode via Greenfield investment as

compared to a subsidiary entry mode via acquisition and to what extent

demographic and technical developments favors a direct bank entry mode over a

brick and mortar bank entry mode in Germany

Section 6 introduces the SWOT analysis as well as the Service Marketing Mix and

applies these concepts to the ING - DiBa case study It illustrates how ING- DiBa

penetrated the German retail banking market with both the implementation of the

direct banking business model and the exploitation of external opportunities

Finally this thesis concludes with a summary of the major findings

5

2 Classification of Banks

21 Bank

This paper refers to banks as defined in the German Banking Act Section 1 GBA

defines financial institutes as enterprises which pursue banking transactions

insofar as the extent of these transactions requires commercial business operations

At least one of the following transactions has to be carried out security

transactions credit transactions payments transactions or other banking business

The enterprise which pursues banking transactions in Germany requires the

permission of the BaFin (Federal Institution for Finance Service Supervision)

according to section 32 GBA

22 Direct Bank

Direct banks are credit institutes which operate without a branch network and

utilize the internet and the telephone as direct communication channels through

which banking transactions are realized and marketing and customer service takes

place Thus direct banks establish cost advantages which they usually transmit in

the form of attractive terms15

23 Brick and Mortar Bank

A brick and mortar (BampM) company is a traditional street-side business that

deals with its customers face to face in an office that the company owns or rents16

A brick and mortar bank serves consumers in a physical facility as distinct from

providing online or telephone services only The term brick and mortar is not a

generally valid classification of a bank but in the jargon of e-commerce it is

frequently employed to distinguish from internet based enterprises In this thesis

the term brick and mortar bank is employed to differentiate between a direct bank

that operates through direct channels and one which operates solely through its

branch network The term brick and mortar is also distinguished from the term

click and mortar which is an expression for a form of multi-channel retailing in

15 Deutsche Bundesbank (2010) 16 Investopedia Dictionary (2010)

6

which both electronic distribution channels (click) and physical premises (mortar)

are utilized17

24 Multinational Bank

Multinational banks are defined as banks that have a physical presence in more

than one country In contrast international banks engage in cross-border operations

but do not establish a physical presence in foreign countries18

25 Retail Bank

There is no generally valid classification of retail banking in theoretical literature

or in practice19 A distinction in retail banking is often made with regard to its

target clientele In this regard some authors define retail banking as the offering of

banking and financial services to individuals and small and medium sized

enterprises20 Other sources define retail banking as the provision of these services

solely to individuals21 This paper employs the following classification of retail

banks `A retail bank is a bank that caters for ordinary individuals and small

business as distinct from large corporations Retail banking operations offer

deposit facilities lend money transfer funds and are prepared to deal in relatively

small amounts`22 In contrast to private and corporate banking retail banking

considers private clients with low to average income as well as small corporate

clients

2

Figure 1 Classification of retail banking clients

(own illustration based on Swoboda 2004)

17 Gabler Wirtschaftslexikon (2010) 18 Hersh and Weller (2002) 19 Muumlller and Joumlhnk (2005) 20 Pond (2007) FinanceWiki (2008) Tremblay and Tremblay (2007) 21 Frei Harker and Hunter (1998) Online Businessdictionarycom (2010) Investoglossarycom (2010) 22 Essvale Corporation Limited (2007)

Retail Banking

Medium and large corporate clients

Wealthy private clients

Small Corporate clients

Private clients

7

3 Market Entry Theories and Strategies

31 Transaction Costs Theory

In the transaction cost theory developed by Ronald Coase and Oliver E

Williamson a comparison of transaction costs determines the optimal form of

organization In TC Theory the entry mode decision is a tradeoff between the

control and the costs of resource commitment Entry modes vary in three major

aspects the cost of resource commitment control as the level of ownership and

environmental risks that may affect the committed resources Hence high-control

modes increase both risk and the potential return23

Williamson differentiates between ex-ante and ex-post transaction costs

Information and searching costs are incurred ex-ante in the process of collecting

market information and identifying suitable partners Negotiation and contract

costs arise ex-ante due to negotiations legal advisory and the determination of

contractual terms Monitoring costs develop ex-post for activities which serve to

control contractual obligations Conflict and enforcement costs arise ex-post due to

the different interpretation of the contract and the costs of enforcing contractual

regulations with sanctions negotiations or through court proceedings Adaption

costs are incurred due to ex-post changes in contractual agreements that become

necessary because of unpredictable developments24

TCE assumes the existence of bounded rationality and opportunism Bounded

rationality describes the limitation in human processing of information and the

planning of possible outcomes Opportunism describes the notion that humans may

act in a self-interested manner by manipulating information and being dishonest

The consequences of these assumptions are incomplete contracts and moral

hazards25 Vice versa opportunism occurs because firms can not write complete

contracts

The size of the transaction costs is determined in each case by the characteristics of

asset specificity uncertainty and frequency Asset specificity arises when the actor

in the market undertakes specific investments in order to fulfill his contractual 23 Chen and Mujtaba (2007) p322 24 Kieser and Ebers (2006) p278 25 Magill and Quenzii (1996) p11

8

obligations It refers to the degree to which long-lasting human or physical assets

are bound in a specific relationship and thus to the extent to which they provide

value in the context of a different situation26 In TCE markets can hardly solve the

problems that high uncertainty creates in combination with bounded rationality and

threats of opportunism Uncertainty includes environmental and behavioral

uncertainty Environmental uncertainty refers to political legal cultural and

economic uncertainties that may affect the success of business transactions

Behavioral uncertainty states that bounded rationality and the threat of opportunism

result in the high costs of monitoring a partner company27 If the similar

transactions are repeated frequently learning effects and economies of scale occur

and will reduce the transaction costs

32 Eclectic Theory

The eclectic theory28 (or OLI paradigm) was developed by John Dunning and is a

framework that merges different economic theories which explain foreign market

entry patterns of multinational corporations29 It states that the internationalization

of MNCs is determined by three sets of independent variables ownership

advantages (or firm- specific advantages) location advantages (or country specific

advantages) and internationalization advantages

The ownership advantage considers the competitive advantages of MNCs arising

from firm-specific characteristics such as size monopoly power economies of

scale management brand name technology and other resource capabilities30

These advantages are usually intangible assets and can be transferred at low costs31

The greater the competitive advantage of the MNC is the more likely it is able to

start or to increase its foreign production32

The location advantages arise from country specific benefits that can be divided

into three categories Firstly a host country may have economic advantages

comprising qualitative and quantitative factors such as production transports costs

26 Dietrich (1994) p18 27 Brouthers and Brouthers (2003) p1183 - 1185 28 Dunning (1980) Dunning (1988) Hill Kwang and Kim (1990) 29 Dunning (2002) 30 Forsbaeck and Oxelheim (2004) 31 Griffin and Pustay (2006) 32 Dunning (2002)

9

communication costs market size or tax incentives Secondly a host country may

offer political advantages in particular governmental policies that may influence

market entry Thirdly a host country may provide social and cultural advantages

including the psychic distance between the foreign and the domestic country as

well as language or cultural aspects that may have an impact on the market entry

decision The higher the attractions of the specific location the more likely it is that

MNCs will exploit their ownership advantage by entering the foreign market33

Because of the existence of transactions costs the internationalization incentive

advantage states that it must be profitable for the MNC to exploit these advantages

itself rather than through local companies (eg licensing)34

In economic literature the OLI paradigm has also been applied to the banking

sector In this regard ownership advantage may include easy access to a vehicle

currency Locational advantages may include country-specific regulations and

entry barriers Internationalization advantages can be information advantages and

access to local deposit bases35

Many empirical studies on the banking market have utilized the eclectic paradigm

as a basic framework For example a study of bank entry into CEE markets

concludes that the ownership advantages of foreign MNBs are strong compared to

banks in emerging markets and especially when the foreign country experiences a

banking crisis36 An application of the OLI paradigm to the Spanish banking

market has shown that bank size and multinational experience of MNBs favor

stronger commitment in the foreign country whereas distance is an entry barrier37

However theoretical literature also states that in service industries clients close to

the MNBs headquarters may be served from this location whereas clients in distant

markets require a physical presence of the MNB in the foreign country which

favors a foreign market entry with increasing distance38

33 Dunning (2002) 34 Hagen (1997) 35 Yannopoulus (1983) 36 Uiboupin and Sorg (2006) 37 Blandoacuten (1998) 38 Blondoacuten (1998) Terpstra and Yu (1988)

10

33 Strategy of Defensive Expansion

A common approach employed to explain the expansion of MNBs involves the

theory of defensive expansion which is also referred to as the acutefollow-the-

customeracute argument

This theory states that MNBs expand abroad in order to provide services for

domestic clients which are often large enterprises that have entered a foreign

market39 The provision of financial services in the foreign country usually requires

a presence at important economic centres Hence to some degree expanding

corporations impose pressure on their domestic banks to follow-up40

The term acutedefensiveacute is derived from the idea that a failure to expand may lead to a

loss of the client not only in the foreign country but also in the domestic one as

the client may associate with a foreign MNB41 Consequently MNBs which pursue

this strategy seek to prevent losses rather then to generate new profits in the foreign

market42 Furthermore the domestic bank has an incomparable competitive

advantage over banks in the foreign country with regard to the knowledge of

customer needs the respective risk of credit default as well as an interest in cross-

selling products such as financial advisory43

Due to earlier business relationships with the client the domestic bank has reduced

costs for examining the financial capacities of the respective enterprise and thus

can offer cheaper services44 Most foreign entry evidence supports the defensive

expansion theory45

A study on this theory with respect to retail banking has revealed that MNBs

sometimes expand abroad in order to provide banking services to specific

communities46

39 Trend im retail-banking koumlhler 40 Henneberger and Graf (2000) 41 Mullineux and Murinde (2003) 42 Naaborg (2007) 43 Knoop (2006) 44 Bhattacharya (1994) 45 Bhattacharya (1994) Naaborg (2007) 46 Tschoegl (1987)

11

34 Strategy of Offensive Expansion

MNBs that offensively expand abroad primarily seek to increase their customer

base both in the home and in the foreign country Firstly the establishment of

foreign branches and subsidiaries enables the MNB to expand their services to

domestic residents who benefit from the international orientation of the bank

These may include customers that have business partners in the foreign country

Secondly MNBs may target new customers in the foreign country in particular

MNEs or foreign subsidiaries of domestic enterprises As the MNB must in both

cases entice customers away from other banks the MNB has to offer attractive and

competitive conditions for their financial services47

47 Buumlschgen (1998) p604

12

4 Industry Analysis German Retail Banking Sector

41 Porter`s Five Forces

In the school of Industrial Economics the five-forces model has established itself

as a core element of industry analysis Porter`s analysis framework is built on the

following five market forces that shape the strategy of competitors threat of new

entrants threat of substitute products or services bargaining power of buyers and

suppliers as well as rivalry among existing competitors

Porterrsquos concept is based on the knowledge that the strategy of an enterprise must

orient itself to its market environment whereby the competitive strategy arises

from a differentiated understanding of the market structure and the knowledge of

how it changes The effects of these forces determine the intensity of the

competition in a market and with it its profitability and attractiveness Therefore

the aim of the enterprise strategy should be reflected in the search for possibilities

for the reduction or use of these competitive forces relative to its own enterprise In

this regard Porter`s model is conducive to the analysis of the driving forces

working in the respective industry

Figure 2 Michael E Porter`s five forces model (Own illustration based on Porter 1979)

Industry Rivalry

Threat of New

Entrants

Bargaining Power of

Buyers

Threat of Substitute Products

and Services

Bargaining Power of Suppliers

13

Porter`s framework is a useful and frequently utilized analytical tool to describe the

foundations of industry competition

A high degree of rivalry among the existing enterprises leads to high competitive

pressure and can lower profit margins and the profitability of individual

enterprises In situations in which a large number of enterprises target similar

market segments with comparable strategies in which the market grows slowly

price is the most important differentiation factor and high exit barriers exist a

negative impact on the industryrsquos profitability is effected48

The threat of new entrants can be determined by the entry barriers of a market The

competitive pressure on existing enterprises increases with low entry barriers In

such a situation important elements of the market (eg shares of the market price

level) can change due to the entry of new market participants49

The bargaining power of buyers determines to what extent customers can influence

enterprises by the amount of consumption and the pressure on margins Important

indexes of a high degree of buyer power include high fixed costs in the industry

existence of supplements of the product or service high degree of customer

concentration customers` knowledge of production costs possibility of a reverse

integration of customers high growth rates of the market and a strong

individualization of customer demand50

The bargaining power of suppliers affects industry profitability if for example a

concentrated supplier group dominates over existing enterprises in the market

which are not important buyers for the suppliers Then the industry faces high

margin pressure by the suppliers

A threat of substitute products and services exists in particular if cheaper or higher-

quality products and services are able to reduce existing sales volumes of a market

or an enterprise51 The future sales potential of existing enterprises becomes limited

and industry competition increases

48 Porter (1985) 49 Porter (1979) Recklies (2001) 50 Recklies (2001) 51 Recklies (2001)

14

Critics of this model state that it neglects the impact of complements as a sixth

force of the industry since they may facilitate or hinder the commercialization of

certain goods However Porter argues that complements are not a force itself but

they affect profitability in the way that they influence the five forces and that `the

strategist must trace the positive or negative influence of complements on all five

forces to ascertain their impact on profitability`52

One limitation of this model is based on studies which indicate that company-

specific factors may have a more important impact on profit than industry forces53

Furthermore the model suggests relatively static and stable market structure which

makes it difficult to assess contemporary dynamic markets54

The model does not assess the impact of the parent company on its subsidiary

which is especially important in the banking sector in which parent companies

often have a strong impact on the performance of their subsidiary or branch The

parenting advantage includes the stand-alone influence through monitoring and

influence on management decisions or capital expenses Furthermore parents

create value by enhancing synergies within the group offering corporate functions

or managing portfolios55

42 Rivalry among existing competitors

In this section the intensity of competitive rivalry among existing competitors in

the German retail banking sector is discussed In this regard an analysis of industry

structure industry growth and exit barriers will be conducted

Industry structure The German banking market is characterized by a three-pillar

system which is reflected by the strict distinction between public-law banks

cooperative banks and private banks56 Each pursues different goals and is subject

to different regulations Private commercial banks pursue the goal of profit

maximization whereas saving banks serve the public contract of offering secure

52 Porter (1997)p11 53 Zack (1999) 54 Recklies (2001) 55 Goold Cambpell and Alexander (1994) 56 Gramlich (2005)

saving possibilities and loans C

interest of their members

banking market is structured as follow

Figure 3(own illustration based on Sch

Public-law banks including saving banks and state banks

total balance sheet volume of banks in Germany

do not participate in retail banking The cooperative bank sector amounts to 11

the total including cooperative banks

cooperative central banks

commercial banks including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

31 of total balance sheet volume

European Research (ZWE) 43 of experts state that the three

important or very important and

for the low number of cross

In order to describe industry rivalry among maj

retail sector the following table illustrates the number of customers per bank in

Germany

57 Engerer (2006) 58 Koumlhler (2008b)

banks 24

Private commercial banks 31

15

possibilities and loans Cooperative banks primarily serve the economic

interest of their members57 In terms of total balance sheet volume the German

banking market is structured as follows

Figure 3 Structure of the German Banking Sector(own illustration based on Schrooten 2009)

law banks including saving banks and state banks amount to 33 of the

total balance sheet volume of banks in Germany However state banks

do not participate in retail banking The cooperative bank sector amounts to 11

including cooperative banks which participate in retail ban

cooperative central banks which primarily serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

alance sheet volume According to a recent survey of the Center for

European Research (ZWE) 43 of experts state that the three-pillar system is

important or very important and 33 state that it is the critical factor responsible

cross-border mergers and acquisitions in Germany

In order to describe industry rivalry among major banks that participate in the

the following table illustrates the number of customers per bank in

Savings banks 13

State banks 20

Cooperative central banks

3Credit cooperative banks 8

Other banks 24

serve the economic

sheet volume the German

Structure of the German Banking Sector

amount to 33 of the

However state banks generally

do not participate in retail banking The cooperative bank sector amounts to 11 of

participate in retail banking and

serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks amount to

According to a recent survey of the Center for

pillar system is

33 state that it is the critical factor responsible

border mergers and acquisitions in Germany58

or banks that participate in the

the following table illustrates the number of customers per bank in

State banks 20

Cooperative central banks

16

Figure 4 Customers of German Banks at the end of 2007 in millions (own illustration based on Deutsche Bank 2008)

With approximately 50 million customers savings banks are the market leader in

the German retail banking sector Although state liability assumption for savings

banks was abolished in 2005 because the EU saw in it an unacceptable subsidy to

the disadvantage of private banks customers still associate the name `Sparkasse`

with state guarantees The specific characteristic of a saving bank is based on its

public contract in that it has to accept customers with poor credit-worthiness that

profits should be used to enhance public wealth and that the middle class should be

supplied with loans59

With approximately 30 million customers cooperative banks are the second major

player in the German retail banking sector Nearly half of these customers are

members of the cooperative banks60 In contrast to the profit maximization goal of

private commercial banks their aim is to fund their members and secure their

economic independence Although cooperative banks are economically and legally

independent in the different regions they appear uniformly as a group under the

brand of ldquoVolks- und Raiffeisenbankenrdquo With regard to growth in customer base

cooperative banks benefit from the advantage of having the regional flexibility that

59 Kruck (2008) 60 Online Raiffeisen Bank Homepage

31

4

61

118

242

30

50

0 10 20 30 40 50 60

Citibank

Hypovereinsbank

ING DiBa

Commerzbank and Dresdner Bank

Postbank and Deutsche Bank

Credit Unions (Volksbanken)

Savings Banks (Sparkassen)

17

allows for topical advertisement as well as a centralized management focus on

improving reputation61

The third group comprises the major private commercial banks including Deutsche

Bank Postbank Commerzbank and Hypovereinsbank Deutsche Bank is a leading

multinational investment bank but with relatively low market share in the retail

banking market Deutsche Bank (97 million clients) is acquiring Postbank (145

million clients) with its broad branch network in a three-step process Together

they have 242 million clients However Heino Ruland from the analyst company

Frankfurt Finanz Partner argues that Deutsche Bank might not be able to capitalize

on the financially weaker Postbank clients as Deutsche Bank is specialized in

corporate clients62 With regard to rivalry intensity and market profitability Rainer

Neske supervisory board member and head of private amp business clients of

Deutsche Bank emphasizes that the German retail banking market is too

fragmented to be highly profitable and that Deutsche Bank does not seek to

compete on the price level but defines itself through performance quality and

consultancy63

Commerzbank is the second largest private commercial bank in Germany After the

acquisition of Dresdner Bank in 2009 Commerzbank now serves more than 12

million clients (of these 11 million private and one million corporate clients) and

pursues the goal of becoming the market leader in Germany64

UniCredit Bank AG with the brand name Hypovereinsbank (HVB) is a subsidiary

of UniCredirSpA and is the third largest private commercial bank in Germany

HVB serves approximately four million clients predominantly in north Germany

and in Bavaria As its retail banking segment could only report marginal profits in

2009 speculation about a sale or acquisition in this segment has come up As the

Swedish SEB (Skandinaviska Enskilda Bank) is considering selling its German

retail segment with 174 branches and one million clients experts now regard HVB

as a major buying candidate65

61 Schwarzbauer (2009) 62 Kreiler (2008) 63 Deutsche Bank (2009) 64 Kreiler (2008) 65 Houmlpner and Nagl (2010)

18

ING DiBa AG is a subsidiary of the Dutch ING Group and serves over 6 million

clients In contrast to savings cooperative and the major private commercial

banks ING DiBa is specialized in direct banking which distributes services via

telephone the internet or post instead of through branches In Germany ING

DiBa is the leader in direct banking but there are many other direct banks such

as Comdirect (a subsidiary of Commerzbank) Volkswagen Bank or DAB Bank

(a subsidiary of HVB) Competition takes place not only among direct banks but

also between direct and branch banks For instance many saving banks have

blocked the opportunity for customers of direct banks to withdraw cash from their

automated teller machines As savings banks can only charge Euro 174 for

withdrawals via visa cards they fear that direct banks can gain market share by

offering attractive account options with a convenient wide-area ATM provision66

Targobank (former Citibank Deutschland) was acquired by the French

cooperative bank Creacutedit Mutel and now serves more than 34 million clients in

Germany in 2010 The bank is specialized in private retail customers with

branches and direct banking67

In conclusion the degree of concentration in the German retail banking market is

very low which reduces the overall profitability of this sector for two main

reasons Banks earn higher profits in concentrated markets as they obtain either

monopoly rents (structure-conduct-performance paradigm) or due to high market

shares that are gained by more efficient and profitable banks (efficient structure

hypothesis)68 As retail banking services are largely standardized product

differentiation is low and price differentiation is often the only option As public-

law banks serve other interests than profit maximization existing private banks

and MNBs that want to enter this market have a competitive disadvantage The

low switching costs of clients intensifies competition on the price level and thus

reduces the profitability of the market However brand identification and

customer relationships are also important which decreases the willingness of

clients to switch solely on the basis of price comparison In summary market

structure indicates a very high degree of rivalry among existing competitors

66 Online Financial Times Deutschland (2010) 67 Targobank (2010) 68 Havrylchyk and Jurzyk (2006) p15

19

Industry growth In this section industry growth will be examined in a dynamic

analysis of three relevant market growth indicators the future long-run

development of the German population the historical development of the number

of banks and branches in Germany and the historical development of market-

share allocation in the context of major retail banking activities

In the long-run market growth depends on the future numerical development of

the market`s customers - the German population As the growth of population

through birth and immigration is smaller than its decrease by virtue of the mortality

rate and emigration the Federal Statistical Office in Germany estimates a sharp

decline of the German population

Figure 5 Estimated Development of German Population (in millions)

(Federal Statistical Office 2009)

The Federal Statistical Office predicts that the trend of decline in population since

2003 will continue and intensify Whereas approximately 82 million people lived

in Germany in 2008 only between 65 million (average lower limit of the

population with 100000 immigrants yearly) and 70 million people (average

upper limit of the population with 200000 immigrants yearly) will reside in

Germany in 2060 Furthermore the decreasing number of births and the ageing of

the current strongly represented middle age group will lead to substantial changes

in the age structure of the population From 2008 to 2060 the proportion of people

from 65 to 80 years will increase 15 to 20 and the proportion of people over

80 years of age will increase from 5 to 14 of the population69 The

69 Federal Statistical Office (2009)

Average lower limit

Average upper limit

20

implications of the aging population for banks will be discussed in the comparison

between direct banks and BampM banks in section 66 of this thesis

The second indicator of industry growth deals with the number of banks and bank

branches in the German market The overall number of banks in Germany

decreased from 3785 in 1995 to 2300 in 2006 As retail banking usually depends

on the number branches maintained their development in Germany will be

examined

Figure 6 Development of Total Bank Branches in Germany (own illustration based on Koumlhler2008a)

Savings banks and cooperative banks have reduced the number of branches

significantly Public-sector banks (savings banks state banks etc) with 18757

branches and cooperative banks with 16028 branches in 1998 reduced the

number of branches to 14252 and 12303 respectively in 2006 Moreover the

number of branches of major commercial banks decreased from 19055 in 1998 to

8879 in 2006

The main cause for the decrease of branches is the high fixed costs which can not

be recouped from low-revenue standard products that can also be distributed

through alternative low-cost channels such as the internet70

70 Koumlhler and Land (2008)

67930 6666363186

59929 58546 5693653931

5086847244 45467 44100

40332

0

10000

20000

30000

40000

50000

60000

70000

80000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

21

As a third indicator of industry growth this paper reflects on the allocation of

market share within the retail banking sector in order to indentify trends that may

affect overall market growth This paper will reflect on market share in two major

retail banking segments - savings deposits and loans The German Central Bank

classifies the banking market in terms of savings banks cooperative banks direct

banks and credit banks The latter include universal banks which are private

commercial banks branches of foreign banks regional banks and other private

banks

This section reflects the development of market share regarding short- medium-

and long-term saving accounts and examines the allocation of loans to corporate

clients consumers (consumer loans) private households and self-employed

persons

In the period from 1998 to 2006 the market for medium-term saving deposits with

a cancellation period under three months has been dominated by saving banks (53

market share in 2006) and cooperative banks (29 market share in 2006) In the

same period the market share for long-term saving deposits with a cancellation

period above three months has also continuously been dominated by savings banks

(65 market share in 2006) and cooperative banks (24 market share in 2006)

However with regard to deposits that mature daily direct banks were able to

increase market share from approximately 15 in 1998 to over 15 in 2006

Figure 7 Market share development of saving accounts that mature daily (own illustration based on Deutsche Bundesbank 2007)

000

500

1000

1500

2000

2500

3000

3500

4000

4500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Banks

Cooperative Banks

Savings Banks

Credit Banks

22

From 1998 to 2006 market share for loans for corporate clients has been

continuously dominated by credit banks (53 market share in 2006) and savings

banks (34 market share in 2006) However this data also comprises loans for

medium and large corporations which are not part of the retail banking market

Loans for private households and self-employed persons have predominately been

granted by savings banks (39 market share in 2006) credit banks (30 market

share in 2006) and cooperative banks (25 market share in 2006) though direct

banks were able to gain some market share from 0 in 1998 up to 5 in 2006

Even more significantly direct banks were able to gain over 16 market share in

the segment of consumer loans

Figure 8 Market share development of consumer loans (own illustration based on Deutsche Bundesbank 2007)

Hence the most significant growth indicator of the retail banking market results

from the emergence of direct banks which were able to gain substantial market

share in consumper loans and deposits that mature daily

In conclusion the industry growth analysis indentifies the following growth

indicators Firstly a sharp decrease in the German population in the following

decades will reduce growth and increase industry rivalry Moreover the

demographic change increases the proportion of old people in the population

Secondly the number of branches in Germany is decreasing due to high fixed

costs of branches In order to be profitable in retail banking the existing branches

must serve a large quantity of customers which leads to strong competition

relative to market share Thirdly the development of market share allocation

000

1000

2000

3000

4000

5000

6000

7000

2002 2003 2004 2005 2006

Savings Banks

Cooperative Banks

Direct Banks

Credit Banks

23

indicates that only direct banks have experienced significant growth from 1995 to

2006

Exit barriers From a perspective of Transaction Costs Economics one can argue

that exit barriers in branch banking are high for market participants as branches

and staff are highly specific assets that lose value when used in another situation

To a large extent these assets are locked into the context of retail banking

Moreover public-law banks usually have to serve the population regardless of

whether they are profitable or not In a situation in which a bank continuously

experiences losses staff and branches may be considered as sunk costs and thus

economically `irrationalacute exit barriers However theories suggest that staff and

branches are practically valid exit barriers and cause MNCs to stay in a market71

The high degree of exit barriers intensifies the strong rivalry among existing

competitors

43 Threat of New Entrants

New entrants usually seek to gain market share while applying pressure on prices

and costs and thus increasing the investments necessary to compete An expert

survey conducted by the ZEW emphasizes the importance of entry threat to the

German retail-banking market 6666 of market experts state that new

competitors (eg foreign banks) have an important or a very important impact on

industry rivalry72

In this section the threat of new entrants to existing market participants in the

German retail banking sector is discussed In this regard this section evaluates

legal entry barriers capital requirements the necessity of large scale operations

customer switching costs and incumbency advantages of existing domestic banks

Legal entry barriers are determined by governmental regulations in the German

Banking Act (GBA) and are supervised by the Federal Supervisory Authority73

According to section 32 para 1 (1) GBA companies that intend to pursue

commercial banking transactions or financial services in Germany require written

71 Hill Hwang and Kim (1990) 72 Koumlhler and Lang (2008) 73 Bundesanstalt fuumlr Finanzdienstleistungsaufsicht (2005)

24

permission from the Federal Financial Supervisory Authority ( ldquoBundesanstalt fuumlr

Finanzdienstleistungaufsichtrdquo) The execution of banking transactions or financial

services also exists when the operator has its headquarters or primary residence

abroad but repeatedly targets companies or individuals who have their primary

residence in Germany In order to obtain the permit several requirements are

examined (eg business plan qualified management etc)

Companies from third countries which intend to conduct banking transactions and

provide financial services in Germany must establish a subsidiary (section 32 para

1 in connection with ection 33 para 1 (6) GBA) or a branch (section 32 para 1 in

connection with section 53 GBA) in Germany Companies from third countries can

apply for an exemption according to section 2 para 4 GBA if the company is

supervised utilizing international accounting standards in the home country and the

responsible authority works together with the BaFin According to section 53b

GBA companies of EEA states are allowed to establish branches (section 53b para

2) but are also free to conduct cross-border financial services without a domestic

presence (section 53b para 2a) Section 32 para 1 GBA does not apply to business

that is motivated by the initiative of the domestic individual or enterprise (so called

passive service freedom)

Representations are limited to their representative function and are not allowed to

conduct or initiate any banking business

Capital requirements are low for cross-border lending and and relatively low for

representations With high equity modes such as branches and even more so with

subsidiaries capital requirements are relatively high as capital is required for

building a broad network of facilities and offering credit to customers Capital

requirements for direct banks are relatively low compared with those of BampM

banks

The necessity of large scale operation is related to the competitive advantage of

economies of scale A company that serves the market in the context of larger

quantities benefits from lower cost per unit In retail banking profit is gained by

having a large number of clients It is expensive to build up these numbers and to

establish a distribution network to serve them This necessity relates directly to the

strategy of the bank An acquisition offers a shortcut to these facilities although the

25

costs of integration can be high as well74 A MNB may also decide to target only a

certain geographical area with certain clients and therefore do not have to enter on

a very large scale

Customer switching costs are different for each individual In general customers

can easily change their banks and open a deposit account or apply for a loan at

another bank However they have to compare the different terms for usually small

transactions to evaluate the convenience of having a bank nearby and then to

decide to terminate the relationships with their current bank75

Finally the incumbency advantages of existing banks are important entry barriers

In particular they include established brand reputation possession of the most

favorable geographical locations and market knowledge Moreover established

banks may already have exclusive contracts with SMEs76

To conclude legal entry barriers are low and particularly low for banks from the

EEA Capital requirements for entering the market are high yet as far as equity

entry modes are concerned direct banks require relatively low capital as they

distribute their services through low-cost channels Banks need to attract many

customers to be profitable but banks strategy dictates whether or not to entrance

should occur on a large scale Moreover the incumbency advantages of existing

banks constitute important entry barriers

44 Threat of Substitute Products or Services

A substitute in retail banking is a service that offers an attractive trade-off to a bank

service or product As individuals and small firms do not regularly report financial

information as do large enterprises they rely primarily on bank lending However

there are additional forms of financing in the private equity or dept market77

Many non- and near- banks provide substitute products and services Near-banks or

quasi-banks are suppliers of financial services but are not classified as credit

institutes according to section 1 GBA Near-banks such as insurance companies or

credit card organizations however do provide substitute products or services Non-

74 Hughes and MacDonald (2009) 75 Adams (2002) 76 Adams (2002) 77 Xiaoqin and Terada-Hagiwara (2003)

26

banks such as department store chains catalog companies or car producers also

provide substitute services78 For instance instead of taking out a loan in order to

pay for a product individuals or small enterprises may decide to take on a leasing

contract for a certain asset or small enterprises can obtain a trade credit as well

Individuals may decide on buying products from insurance companies instead of

putting money into a bank account

Another substitute for both direct and BampM banks is the person-to-person (p2p)

lending business a new form of borrowing and lending money that takes place in a

web-based market place In this online platform borrowers are connected to

lenders through an auction-like process in which a lender who bids to provide a

loan for the lowest interest rate will be awarded the loan contract with the

borrower A p2p company mediates between private or company borrowers and

lenders and also executes transactions between the parties similar to the role which

e-bay plays in the trade of commercial goods79 The p2p lending business does not

involve traditional banks and thus can offer superior interest rates to borrowers and

higher returns for lenders

45 Bargaining Power of Suppliers

When a supplier group is more concentrated than the industry does not primarily

depend on the industry and when the industry faces high switching costs the

supplier group has strong bargaining power and can reduce the profit potential of

an industry In the retail banking market the most relevant suppliers include human

resources suppliers of capital resources and suppliers of information and

communication technology (ICT)80 Highly talented or experienced specialists are

strongly canvassed and have strong bargaining power with respect to their salary

and working conditions However in the aftermath of the financial crisis many

banks are planning a reduction of staff According to a study of Ernst amp Young

every fifth bank intends to decrease staff and only every 10th bank is planning an

increase81 Given the current situation of the employment market the bargaining

power of employees is relatively low Suppliers of highly specialized banking ICT

78 Gabler Wirtschaftslexikon (2010) 79 Deloitte (2009) p 12 80 Buumlschgen and Boumlrner (2003) 81 Ernst amp Young (2009)

27

solutions have strong bargaining power as switching costs for these systems are

very high Moreover the higher yield requirements of shareholders can be

interpreted as supplier power

46 Bargaining Power of Buyers

In retail banking there are many buyers with relatively low transaction volumes

which weakens their bargaining power However retail banking services are

standardized and buyers can easily find similar services Switching costs have

usually been relatively high for these low volume transactions but in the age of the

internet the market is very transparent and buyers can screen different offerings

more easily This does not necessarily imply that the cheapest banking service will

be chosen automatically as customers also seek a trustworthy brand especially in

times of financial crisis Moreover there are other factors that affect the switching

cost of the individual such as the location of the branch Yet there is a tendency

towards the increasing bargaining power of buyers

This is also substantiated by the ZEW survey 7984 of market experts state that

decreasing customer loyalty and increasing price sensibility are important or very

important factors with respect to the intensity of competition in the German retail

banking sector A comparison of former and modern retail customers also indicates

that the bargaining power of retail banking service users has increased

Former Retail Customer Modern Retail Customer

Passive information seeking

behavior

Active information seeking behavior

Hardy or little informed Good to very good know-how

High customer loyality Increasing willingness to switch

Fixation on the branch Expects multi-channel banking at all times

and places

Little market transparency High price transparency

Relatively undemanding Demanding

Figure 9 Comparison of former and modern retail customers (own illustration based on Swoboda 2004)

28

5 Foreign Bank Entry Strategies in Germany

This section illustrates mode choices for foreign bank entry in Germany Based on

the hierarchical model of market entry modes82 the foreign bank has the choice of

equity and non ndash equity modes of entry An advantage of the hierarchical model is

that it allows comparing between entry modes on different levels The main

difference between equity and non ndash equity modes is the degree of resource

commitment in the foreign country As classified at the beginning of this thesis

non-equity entry refers to international banking and equity entry refers to

multinational banking

The research question of this thesis considers multinational bank entry modes

International banking however is often a first step towards multinational banking

Hence this thesis will also discuss cross-border lending and alliances as non ndash

equity entry modes The following figure illustrates a comprehensive view of

market entry modes for banks

Figure 10 A hierarchical model of entry mode choices for banks (own illustration based on Pan and Tse 2000)

82 Pan and Tse (2000)

Entry Mode Choices

Non - Equity Modes

Export

Cross Border Lending

Contractual Agreements

Alliances

Equity Modes

Equity Joint Ventures

Greenfield Investment

Branch

Subsidiary

Representation

Acquisition

Subsidiary

Branch

29

The hierarchical model illustrates the various entry mode choices for entering the

German retail banking market The creation of a common European financial

market in which banks can integrate freely is a major goal of the European Union83

The previous section of this paper indicates that entry barriers are relatively low

and that the German market is highly competitive Hence the choice of a proper

entry mode which is appropriate to the capabilities and the strategy of the bank is

even more significant Therefore the following section will reflect on the strategic

concept governing the choice of entry modes as well as the proliferation of these

entry modes in the German retail banking market

An international bank that is not interested in investing equity in the foreign

market can enter by means of cross-border lending or by forming a non-equity

alliance These non-equity entry modes can help the bank to access niche markets

or to exploit locational advantages when the bank is located near the German

border

However a retail bank defined in the beginning of this paper as a bank that

`caters for ordinary individuals and small businessacute and that seeks to enter the

German market in order to gain significant revenue from deposits and loan

business might have to consider a physical presence in the foreign country

The analysis considers entry modes that are perceived as international banking

cross-border lending and non-equity strategic alliances Furthermore the equity

modes JVs and representations will be discussed

Subsequently this section compares the market entry of a branch through

Greenfield investment with the market entry of a subsidiary by virtue of

acquisition as these modes of entry are the most common in the German retail

banking market

Finally the following question will be addressed to what extent do demographic

and technical trends favor a direct bank entry mode over a brick and mortar bank

approach in Germany

83 Fidrmuc and Hainz (2008)

30

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks (own illustration)

51 Non ndash equity modes Export ndash Cross-Border Lending

Cross-border lending is equivalent to the export entry mode and is a simple non-

equity strategy to enter a foreign market A bank which participates in cross-

border lending must assess the creditworthiness of the individual borrower as well

as the country risk which involves the possibility that these loans will be impaired

by economic or political proceedings in the foreign country84 The country risk in

Germany is rather low as it is perceived to have a solid political and economic

situation (Country Rating A2) with a stable and a very efficient business

environment (Country Rating A1)85 As a bank will only have limited access to soft

information about the creditworthiness of the borrower the availability of loans

usually decreases and the interest on loans usually increases with distance86 Soft

information for private loans includes the previous experience with the account

management of the credit user environmental facts and a judgment relative to his

employment contract87 For corporate loans soft facts may include the market

environment corporate structure management a business plan as well as

84 Hughes and McDonald (2003) 85 Online wwwtrade-safelycom (2009) 86 Agrawal and Hauswald (2007) 87 Dizil (2009)

Entry Mode Choices of MNBs

Greenfield Investment

Branch

Brick and Mortar Bank Direct Bank

Acquisition

Subsidiary

Brick and Mortar Bank Direct Bank

II

Eidesstattliche Erklaumlrung

Hiermit erklaumlre ich von Eides Statt die vorliegende Arbeit eigenstaumlndig und nur unter

Verwendung der angegebenen Hilfsmittel angefertigt zu haben

Die aus fremden Quellen direkt oder indirekt gewonnenen Gedanken sind als solche

kenntlich gemacht

Die Arbeit wurde bisher in gleicher oder aumlhnlicher Form keiner Pruumlfungsbehoumlrde

vorgelegt und auch noch nicht veroumlffentlicht

Wien im Juli 2010

Timm Rufo

III

IV

Acknowledgements

Foremost I thank my parents for supporting and encouraging me to pursue this degree

Moreover I would like to thank my brother Marc for his direction and assistance In

particular Marc`s recommendations and suggestions have been invaluable for my

studies and this thesis

In addition I would like to thank Professor Josef Windsperger who provided scientific

support to make this work possible

I would also like to thank Bennett Schwartz Director of International Banking at TD

Bank who gave me the opportunity to work in his department and sparked my interest

in the theme of this thesis

Last but not least special thanks should be given to my student colleagues who helped

me in many ways In particular I thank Urszula Gudacz who has been an exceptional

friend and a great support during my years of study

V

VI

Table of contents

List of Figures VIII

List of Abbreviations IX

1 Introduction 1

11 Research Objective 2

12 Structure 2

2 Classification of Banks 5

21 Bank 5

22 Direct Bank 5

23 Brick and Mortar Bank 6

24 Multinational Bank 6

25 Retail Bank 6

3 Market Entry Theories and Strategies 7

31 Transaction Costs Theory 7

32 Eclectic Theory 8

33 Strategy of Defensive Expansion 10

34 Strategy of Offensive Expansion 11

4 Structure Analysis German Retail Banking Market 12

41 Porter`s Five Forces 12

42 Rivalry Among Existing Competitors 14

43 Threats of New Entrants 23

44 Threats of Substitutes 25

45 Bargaining Power of Suppliers 26

46 Bargaining Power of Buyers 27

5 Foreign Bank Entry Strategies in Germany 28

51 Cross-border lending 30

52 Alliances 31

VII

53 Joint Ventures 32

54 Representations 33

55 Entry Mode Choice Greenfield-Branch vs Acquisition-Subsidiary 34

56 Business Model Choice Direct Bank vs Brick and Mortar Bank 38

561 Demographical Trends 40

562 Technological Trends 42

6 Case Study ING DiBa 45

61 Corporate Profile ING Group 45

62 Market Entry and Market Penetration 45

63 SWOT Analysis 46

64 ING DiBa SWOT Analysis 48

641 Strengths 48

642 Weaknesses 48

643 Opportunities 49

644 Threats 49

65 The Service Marketing Mix 50

66 ING DiBa Marketing Mix (7Ps) 52

67 Summary 55

7 Conclusion 56

Literature

Appendix

VIII

List of Figures

Figure 1 Classification of retail banking clients 6

Figure 2 Michael E Porter`s Five Forces model 12

Figure 3 Structure of the German banking sector 15

Figure 4 Customers of German banks at the end of 2007 (in millions) 16

Figure 5 Estimated development of the German population (in millions) 19

Figure 6 Development of total bank branches in Germany 20

Figure 7 Market share development of accounts that mature daily 21

Figure 8 Market share development of consumer loans 22

Figure 9 Comparison of former and modern retail banking customers 27

Figure 10 A hierarchical model of entry mode choices for banks 28

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks 30

Figure 12 Development of foreign MNBs branches in Germany 35

Figure 13 Development of foreign MNBs subsidiaries in Germany 37

Figure 14 SWOT analysis 47

Figure 15 Service Marketing Mix 51

IX

List of abbreviations

ATM Automated Teller Machine

BampM Brick and Mortar

CEE Central and Easter European

EEA European Economic Area

FDI Foreign Direct Investment

GBA German Banking Act

ICT Information and Communication Technology

JV Joint Venture

MNB Multinational Bank

MNE Multinational Enterprise

RDC Remote Deposit Capture

SMEs Small and Medium Sized Enterprises

TCE Transaction Costs Economics

WOS Wholly Owned Subsidiary

ZEW Centre for European Economic Research

1 Introduction

In the aftermath of the recent financial crisis1 and in times in which banks

rediscover the private individual ndash also described as the renaissance of retail

banking2 - significant attention is now being paid to the market entries of foreign

multinational banks3

The German retail banking market is highly competitive Private cooperative and

state-controlled savings banks compete intensely for market share with hardly any

cooperative activities among the groups As savings banks are owned by German

states towns or local authorities they are protected by law from takeovers by

institutes from the other banking sectors4 Due to the high fragmentation of the

German market hardly any bank has dominant market power The five largest

banks have a total market share of only 20 percent and new competitors enter the

market and attract customers with aggressive price differentiation offers5 The

strong competition among private banks savings banks and co-operative banks

results in low profit margins by international comparison The profit potential in

German private-customer business has fallen for many years From 2000 to 2006

total income from the financial service providers in Germany measured by the

distribution of financial products with private customers fell approximately 15

from euro 675 billion to euro 574 billion6 Though the retail banking sector has

experienced some increase in profits due to cost reduction and reduced loan

failures in 2007 market potential still stagnated in 20097

Since the financial crisis has raised the awareness of the threats of investment

banking many banks have refocused on core business activities in order to

maintain their solvency through increased account deposits Banks need money to

grant loans to private individuals or enterprises provide investment opportunities

finance consumer goods or simply realize baking transactions Yet the recent

financial crisis caused distrust among the banks and loans will not be granted as

1 Plickert (2009) 2 Deutsche Bank (2009) 3 Koumlhler and Lang (2008) 4 Spiegel Online (2007) 5 Welp (2009) 6 Zebrolfesschierenbeckaccosiates (2008) 7 McKinsey amp Company (2007) Zebrolfesschierenbeckaccosiates (2008)

2

easily as before On the consumer side the financial crisis has increased the

demand for secure money investments A survey of 230 highly ranked managers

from private savings and co-operative banks on the effects of the crisis on their

business indicates that banks have concentrated more intensively on business with

private customers both during and after the latest crisis Moreover customer

demand for certificates company shares or funds has fallen significantly while the

demand for standard retail banking products such as call money accounts or

account books has increased substantially8

In spite of its high competitiveness and low profit margins the German retail

banking market is still attractive for foreign banks Foreign MNBs are increasingly

able to penetrate the market for private individuals9 In particular they gain market

share through new products decreasing prices standardized processes and

innovative marketing whereas domestic banks have often relied on continued

customer loyalty10 Although foreign multinational banks in Germany have usually

concentrated on large domestic corporations engaged in international

transactions11 they now enter the market for private and small corporate clients as

well12- a trend that has been supported by the development of internet technology

and other new marketing - channel options

The distinctive characteristics of the German banking market raise several

questions concerning both entry mode and business model considerations of

multinational banks Should a multinational bank engage in cross-border lending or

rather enter the market via foreign direct investment How do the development of

economic political-legal and social-cultural factors in the German market affect a

multinational bank`s entry mode and business model choice

This thesis distinguishes between the non - equity entry modes of cross-border

lending and alliances as well as the equity entry modes of representative offices

branches subsidiaries and JVs both from a Greenfield investment and an

acquisition point of view Each of these organizational entry mode forms has

8 Welp (2009) 9 Reitz (2005) 10 McKinsey amp Company (2007) 11 Hersh and Weller (2002) 12 Koumlhler (2008)

3

distinctive advantages and disadvantages Hence the main focus of this thesis is to

provide a broad understanding of the distinctive market entry and penetration

strategies in light of macro and micro economical developments in Germany

11 Research Objective

This thesis examines entry mode choice decisions and business model

considerations of multinational banks entering the German retail banking sector

The objective is to evaluate the affect of current market developments on their

entry mode decisions

In light of the financial crisis and the banks` rediscovery of the private individual

the German banking sector is currently experiencing a renaissance resulting in

increasing industry rivalry At the same time the processing of bank transactions

and customer services is becoming increasingly independent of the branch

distribution channel and the adoption of new technologies is substantially affecting

the allocation of retail banking services13 The technological evolution is

exemplified by the emergence of web-based direct banks which have been able to

penetrate the retail banking market with low-cost structures innovative ideas and

distinctive service thinking

Eventually the growing importance of the internet and other technological means

as distribution channels on the one hand and the remaining strong demand for

personal consultation on the other hand require a customer-oriented multi-channel

management of the banks14

This paper contrasts the two opposing ends in the field of retail banking

distribution channels It simplifies the entry mode choice between direct banks that

solely operate through the internet and brick amp mortar banks which solely operate

through a branch network Furthermore it differentiates between branch entry via

Greenfield investment and subsidiary entry via acquisition

Two major questions will be addressed

13 Deloitte (2010) 14 Welp (2009)

4

Firstly to what extent do demographic and technical developments favor a direct

bank entry mode over a brick and mortar bank approach in Germany

Secondly what affects the decision in favor of a branch entry mode via Greenfield

investment as compared to a subsidiary entry mode via acquisition in Germany

12 Structure

This thesis is systematically divided into two different complexes - a theoretical

and a practical After a classification of essential banking terms in the section 2

Section 3 then describes relevant market entry theories ndash namely the Transaction

Costs Theory and the Eclectic Theory as well as market entry strategies ndash namely

the offensive and the defensive strategies of expansion

In section 4 the German retail banking market is analyzed within the five forces

framework The goal of this examination is to evaluate market attractiveness and to

identify micro and macroeconomic developments that may shape the market in the

future

Given the theoretical framework of section 3 and the knowledge of industry

structure and trends of section 4 section 5 explores the decision driving factors of

entry mode choice In this section cross-border lending alliances joint ventures

and representations will be discussed Furthermore this section indicates what

affects the decision in favor of a branch entry mode via Greenfield investment as

compared to a subsidiary entry mode via acquisition and to what extent

demographic and technical developments favors a direct bank entry mode over a

brick and mortar bank entry mode in Germany

Section 6 introduces the SWOT analysis as well as the Service Marketing Mix and

applies these concepts to the ING - DiBa case study It illustrates how ING- DiBa

penetrated the German retail banking market with both the implementation of the

direct banking business model and the exploitation of external opportunities

Finally this thesis concludes with a summary of the major findings

5

2 Classification of Banks

21 Bank

This paper refers to banks as defined in the German Banking Act Section 1 GBA

defines financial institutes as enterprises which pursue banking transactions

insofar as the extent of these transactions requires commercial business operations

At least one of the following transactions has to be carried out security

transactions credit transactions payments transactions or other banking business

The enterprise which pursues banking transactions in Germany requires the

permission of the BaFin (Federal Institution for Finance Service Supervision)

according to section 32 GBA

22 Direct Bank

Direct banks are credit institutes which operate without a branch network and

utilize the internet and the telephone as direct communication channels through

which banking transactions are realized and marketing and customer service takes

place Thus direct banks establish cost advantages which they usually transmit in

the form of attractive terms15

23 Brick and Mortar Bank

A brick and mortar (BampM) company is a traditional street-side business that

deals with its customers face to face in an office that the company owns or rents16

A brick and mortar bank serves consumers in a physical facility as distinct from

providing online or telephone services only The term brick and mortar is not a

generally valid classification of a bank but in the jargon of e-commerce it is

frequently employed to distinguish from internet based enterprises In this thesis

the term brick and mortar bank is employed to differentiate between a direct bank

that operates through direct channels and one which operates solely through its

branch network The term brick and mortar is also distinguished from the term

click and mortar which is an expression for a form of multi-channel retailing in

15 Deutsche Bundesbank (2010) 16 Investopedia Dictionary (2010)

6

which both electronic distribution channels (click) and physical premises (mortar)

are utilized17

24 Multinational Bank

Multinational banks are defined as banks that have a physical presence in more

than one country In contrast international banks engage in cross-border operations

but do not establish a physical presence in foreign countries18

25 Retail Bank

There is no generally valid classification of retail banking in theoretical literature

or in practice19 A distinction in retail banking is often made with regard to its

target clientele In this regard some authors define retail banking as the offering of

banking and financial services to individuals and small and medium sized

enterprises20 Other sources define retail banking as the provision of these services

solely to individuals21 This paper employs the following classification of retail

banks `A retail bank is a bank that caters for ordinary individuals and small

business as distinct from large corporations Retail banking operations offer

deposit facilities lend money transfer funds and are prepared to deal in relatively

small amounts`22 In contrast to private and corporate banking retail banking

considers private clients with low to average income as well as small corporate

clients

2

Figure 1 Classification of retail banking clients

(own illustration based on Swoboda 2004)

17 Gabler Wirtschaftslexikon (2010) 18 Hersh and Weller (2002) 19 Muumlller and Joumlhnk (2005) 20 Pond (2007) FinanceWiki (2008) Tremblay and Tremblay (2007) 21 Frei Harker and Hunter (1998) Online Businessdictionarycom (2010) Investoglossarycom (2010) 22 Essvale Corporation Limited (2007)

Retail Banking

Medium and large corporate clients

Wealthy private clients

Small Corporate clients

Private clients

7

3 Market Entry Theories and Strategies

31 Transaction Costs Theory

In the transaction cost theory developed by Ronald Coase and Oliver E

Williamson a comparison of transaction costs determines the optimal form of

organization In TC Theory the entry mode decision is a tradeoff between the

control and the costs of resource commitment Entry modes vary in three major

aspects the cost of resource commitment control as the level of ownership and

environmental risks that may affect the committed resources Hence high-control

modes increase both risk and the potential return23

Williamson differentiates between ex-ante and ex-post transaction costs

Information and searching costs are incurred ex-ante in the process of collecting

market information and identifying suitable partners Negotiation and contract

costs arise ex-ante due to negotiations legal advisory and the determination of

contractual terms Monitoring costs develop ex-post for activities which serve to

control contractual obligations Conflict and enforcement costs arise ex-post due to

the different interpretation of the contract and the costs of enforcing contractual

regulations with sanctions negotiations or through court proceedings Adaption

costs are incurred due to ex-post changes in contractual agreements that become

necessary because of unpredictable developments24

TCE assumes the existence of bounded rationality and opportunism Bounded

rationality describes the limitation in human processing of information and the

planning of possible outcomes Opportunism describes the notion that humans may

act in a self-interested manner by manipulating information and being dishonest

The consequences of these assumptions are incomplete contracts and moral

hazards25 Vice versa opportunism occurs because firms can not write complete

contracts

The size of the transaction costs is determined in each case by the characteristics of

asset specificity uncertainty and frequency Asset specificity arises when the actor

in the market undertakes specific investments in order to fulfill his contractual 23 Chen and Mujtaba (2007) p322 24 Kieser and Ebers (2006) p278 25 Magill and Quenzii (1996) p11

8

obligations It refers to the degree to which long-lasting human or physical assets

are bound in a specific relationship and thus to the extent to which they provide

value in the context of a different situation26 In TCE markets can hardly solve the

problems that high uncertainty creates in combination with bounded rationality and

threats of opportunism Uncertainty includes environmental and behavioral

uncertainty Environmental uncertainty refers to political legal cultural and

economic uncertainties that may affect the success of business transactions

Behavioral uncertainty states that bounded rationality and the threat of opportunism

result in the high costs of monitoring a partner company27 If the similar

transactions are repeated frequently learning effects and economies of scale occur

and will reduce the transaction costs

32 Eclectic Theory

The eclectic theory28 (or OLI paradigm) was developed by John Dunning and is a

framework that merges different economic theories which explain foreign market

entry patterns of multinational corporations29 It states that the internationalization

of MNCs is determined by three sets of independent variables ownership

advantages (or firm- specific advantages) location advantages (or country specific

advantages) and internationalization advantages

The ownership advantage considers the competitive advantages of MNCs arising

from firm-specific characteristics such as size monopoly power economies of

scale management brand name technology and other resource capabilities30

These advantages are usually intangible assets and can be transferred at low costs31

The greater the competitive advantage of the MNC is the more likely it is able to

start or to increase its foreign production32

The location advantages arise from country specific benefits that can be divided

into three categories Firstly a host country may have economic advantages

comprising qualitative and quantitative factors such as production transports costs

26 Dietrich (1994) p18 27 Brouthers and Brouthers (2003) p1183 - 1185 28 Dunning (1980) Dunning (1988) Hill Kwang and Kim (1990) 29 Dunning (2002) 30 Forsbaeck and Oxelheim (2004) 31 Griffin and Pustay (2006) 32 Dunning (2002)

9

communication costs market size or tax incentives Secondly a host country may

offer political advantages in particular governmental policies that may influence

market entry Thirdly a host country may provide social and cultural advantages

including the psychic distance between the foreign and the domestic country as

well as language or cultural aspects that may have an impact on the market entry

decision The higher the attractions of the specific location the more likely it is that

MNCs will exploit their ownership advantage by entering the foreign market33

Because of the existence of transactions costs the internationalization incentive

advantage states that it must be profitable for the MNC to exploit these advantages

itself rather than through local companies (eg licensing)34

In economic literature the OLI paradigm has also been applied to the banking

sector In this regard ownership advantage may include easy access to a vehicle

currency Locational advantages may include country-specific regulations and

entry barriers Internationalization advantages can be information advantages and

access to local deposit bases35

Many empirical studies on the banking market have utilized the eclectic paradigm

as a basic framework For example a study of bank entry into CEE markets

concludes that the ownership advantages of foreign MNBs are strong compared to

banks in emerging markets and especially when the foreign country experiences a

banking crisis36 An application of the OLI paradigm to the Spanish banking

market has shown that bank size and multinational experience of MNBs favor

stronger commitment in the foreign country whereas distance is an entry barrier37

However theoretical literature also states that in service industries clients close to

the MNBs headquarters may be served from this location whereas clients in distant

markets require a physical presence of the MNB in the foreign country which

favors a foreign market entry with increasing distance38

33 Dunning (2002) 34 Hagen (1997) 35 Yannopoulus (1983) 36 Uiboupin and Sorg (2006) 37 Blandoacuten (1998) 38 Blondoacuten (1998) Terpstra and Yu (1988)

10

33 Strategy of Defensive Expansion

A common approach employed to explain the expansion of MNBs involves the

theory of defensive expansion which is also referred to as the acutefollow-the-

customeracute argument

This theory states that MNBs expand abroad in order to provide services for

domestic clients which are often large enterprises that have entered a foreign

market39 The provision of financial services in the foreign country usually requires

a presence at important economic centres Hence to some degree expanding

corporations impose pressure on their domestic banks to follow-up40

The term acutedefensiveacute is derived from the idea that a failure to expand may lead to a

loss of the client not only in the foreign country but also in the domestic one as

the client may associate with a foreign MNB41 Consequently MNBs which pursue

this strategy seek to prevent losses rather then to generate new profits in the foreign

market42 Furthermore the domestic bank has an incomparable competitive

advantage over banks in the foreign country with regard to the knowledge of

customer needs the respective risk of credit default as well as an interest in cross-

selling products such as financial advisory43

Due to earlier business relationships with the client the domestic bank has reduced

costs for examining the financial capacities of the respective enterprise and thus

can offer cheaper services44 Most foreign entry evidence supports the defensive

expansion theory45

A study on this theory with respect to retail banking has revealed that MNBs

sometimes expand abroad in order to provide banking services to specific

communities46

39 Trend im retail-banking koumlhler 40 Henneberger and Graf (2000) 41 Mullineux and Murinde (2003) 42 Naaborg (2007) 43 Knoop (2006) 44 Bhattacharya (1994) 45 Bhattacharya (1994) Naaborg (2007) 46 Tschoegl (1987)

11

34 Strategy of Offensive Expansion

MNBs that offensively expand abroad primarily seek to increase their customer

base both in the home and in the foreign country Firstly the establishment of

foreign branches and subsidiaries enables the MNB to expand their services to

domestic residents who benefit from the international orientation of the bank

These may include customers that have business partners in the foreign country

Secondly MNBs may target new customers in the foreign country in particular

MNEs or foreign subsidiaries of domestic enterprises As the MNB must in both

cases entice customers away from other banks the MNB has to offer attractive and

competitive conditions for their financial services47

47 Buumlschgen (1998) p604

12

4 Industry Analysis German Retail Banking Sector

41 Porter`s Five Forces

In the school of Industrial Economics the five-forces model has established itself

as a core element of industry analysis Porter`s analysis framework is built on the

following five market forces that shape the strategy of competitors threat of new

entrants threat of substitute products or services bargaining power of buyers and

suppliers as well as rivalry among existing competitors

Porterrsquos concept is based on the knowledge that the strategy of an enterprise must

orient itself to its market environment whereby the competitive strategy arises

from a differentiated understanding of the market structure and the knowledge of

how it changes The effects of these forces determine the intensity of the

competition in a market and with it its profitability and attractiveness Therefore

the aim of the enterprise strategy should be reflected in the search for possibilities

for the reduction or use of these competitive forces relative to its own enterprise In

this regard Porter`s model is conducive to the analysis of the driving forces

working in the respective industry

Figure 2 Michael E Porter`s five forces model (Own illustration based on Porter 1979)

Industry Rivalry

Threat of New

Entrants

Bargaining Power of

Buyers

Threat of Substitute Products

and Services

Bargaining Power of Suppliers

13

Porter`s framework is a useful and frequently utilized analytical tool to describe the

foundations of industry competition

A high degree of rivalry among the existing enterprises leads to high competitive

pressure and can lower profit margins and the profitability of individual

enterprises In situations in which a large number of enterprises target similar

market segments with comparable strategies in which the market grows slowly

price is the most important differentiation factor and high exit barriers exist a

negative impact on the industryrsquos profitability is effected48

The threat of new entrants can be determined by the entry barriers of a market The

competitive pressure on existing enterprises increases with low entry barriers In

such a situation important elements of the market (eg shares of the market price

level) can change due to the entry of new market participants49

The bargaining power of buyers determines to what extent customers can influence

enterprises by the amount of consumption and the pressure on margins Important

indexes of a high degree of buyer power include high fixed costs in the industry

existence of supplements of the product or service high degree of customer

concentration customers` knowledge of production costs possibility of a reverse

integration of customers high growth rates of the market and a strong

individualization of customer demand50

The bargaining power of suppliers affects industry profitability if for example a

concentrated supplier group dominates over existing enterprises in the market

which are not important buyers for the suppliers Then the industry faces high

margin pressure by the suppliers

A threat of substitute products and services exists in particular if cheaper or higher-

quality products and services are able to reduce existing sales volumes of a market

or an enterprise51 The future sales potential of existing enterprises becomes limited

and industry competition increases

48 Porter (1985) 49 Porter (1979) Recklies (2001) 50 Recklies (2001) 51 Recklies (2001)

14

Critics of this model state that it neglects the impact of complements as a sixth

force of the industry since they may facilitate or hinder the commercialization of

certain goods However Porter argues that complements are not a force itself but

they affect profitability in the way that they influence the five forces and that `the

strategist must trace the positive or negative influence of complements on all five

forces to ascertain their impact on profitability`52

One limitation of this model is based on studies which indicate that company-

specific factors may have a more important impact on profit than industry forces53

Furthermore the model suggests relatively static and stable market structure which

makes it difficult to assess contemporary dynamic markets54

The model does not assess the impact of the parent company on its subsidiary

which is especially important in the banking sector in which parent companies

often have a strong impact on the performance of their subsidiary or branch The

parenting advantage includes the stand-alone influence through monitoring and

influence on management decisions or capital expenses Furthermore parents

create value by enhancing synergies within the group offering corporate functions

or managing portfolios55

42 Rivalry among existing competitors

In this section the intensity of competitive rivalry among existing competitors in

the German retail banking sector is discussed In this regard an analysis of industry

structure industry growth and exit barriers will be conducted

Industry structure The German banking market is characterized by a three-pillar

system which is reflected by the strict distinction between public-law banks

cooperative banks and private banks56 Each pursues different goals and is subject

to different regulations Private commercial banks pursue the goal of profit

maximization whereas saving banks serve the public contract of offering secure

52 Porter (1997)p11 53 Zack (1999) 54 Recklies (2001) 55 Goold Cambpell and Alexander (1994) 56 Gramlich (2005)

saving possibilities and loans C

interest of their members

banking market is structured as follow

Figure 3(own illustration based on Sch

Public-law banks including saving banks and state banks

total balance sheet volume of banks in Germany

do not participate in retail banking The cooperative bank sector amounts to 11

the total including cooperative banks

cooperative central banks

commercial banks including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

31 of total balance sheet volume

European Research (ZWE) 43 of experts state that the three

important or very important and

for the low number of cross

In order to describe industry rivalry among maj

retail sector the following table illustrates the number of customers per bank in

Germany

57 Engerer (2006) 58 Koumlhler (2008b)

banks 24

Private commercial banks 31

15

possibilities and loans Cooperative banks primarily serve the economic

interest of their members57 In terms of total balance sheet volume the German

banking market is structured as follows

Figure 3 Structure of the German Banking Sector(own illustration based on Schrooten 2009)

law banks including saving banks and state banks amount to 33 of the

total balance sheet volume of banks in Germany However state banks

do not participate in retail banking The cooperative bank sector amounts to 11

including cooperative banks which participate in retail ban

cooperative central banks which primarily serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

alance sheet volume According to a recent survey of the Center for

European Research (ZWE) 43 of experts state that the three-pillar system is

important or very important and 33 state that it is the critical factor responsible

cross-border mergers and acquisitions in Germany

In order to describe industry rivalry among major banks that participate in the

the following table illustrates the number of customers per bank in

Savings banks 13

State banks 20

Cooperative central banks

3Credit cooperative banks 8

Other banks 24

serve the economic

sheet volume the German

Structure of the German Banking Sector

amount to 33 of the

However state banks generally

do not participate in retail banking The cooperative bank sector amounts to 11 of

participate in retail banking and

serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks amount to

According to a recent survey of the Center for

pillar system is

33 state that it is the critical factor responsible

border mergers and acquisitions in Germany58

or banks that participate in the

the following table illustrates the number of customers per bank in

State banks 20

Cooperative central banks

16

Figure 4 Customers of German Banks at the end of 2007 in millions (own illustration based on Deutsche Bank 2008)

With approximately 50 million customers savings banks are the market leader in

the German retail banking sector Although state liability assumption for savings

banks was abolished in 2005 because the EU saw in it an unacceptable subsidy to

the disadvantage of private banks customers still associate the name `Sparkasse`

with state guarantees The specific characteristic of a saving bank is based on its

public contract in that it has to accept customers with poor credit-worthiness that

profits should be used to enhance public wealth and that the middle class should be

supplied with loans59

With approximately 30 million customers cooperative banks are the second major

player in the German retail banking sector Nearly half of these customers are

members of the cooperative banks60 In contrast to the profit maximization goal of

private commercial banks their aim is to fund their members and secure their

economic independence Although cooperative banks are economically and legally

independent in the different regions they appear uniformly as a group under the

brand of ldquoVolks- und Raiffeisenbankenrdquo With regard to growth in customer base

cooperative banks benefit from the advantage of having the regional flexibility that

59 Kruck (2008) 60 Online Raiffeisen Bank Homepage

31

4

61

118

242

30

50

0 10 20 30 40 50 60

Citibank

Hypovereinsbank

ING DiBa

Commerzbank and Dresdner Bank

Postbank and Deutsche Bank

Credit Unions (Volksbanken)

Savings Banks (Sparkassen)

17

allows for topical advertisement as well as a centralized management focus on

improving reputation61

The third group comprises the major private commercial banks including Deutsche

Bank Postbank Commerzbank and Hypovereinsbank Deutsche Bank is a leading

multinational investment bank but with relatively low market share in the retail

banking market Deutsche Bank (97 million clients) is acquiring Postbank (145

million clients) with its broad branch network in a three-step process Together

they have 242 million clients However Heino Ruland from the analyst company

Frankfurt Finanz Partner argues that Deutsche Bank might not be able to capitalize

on the financially weaker Postbank clients as Deutsche Bank is specialized in

corporate clients62 With regard to rivalry intensity and market profitability Rainer

Neske supervisory board member and head of private amp business clients of

Deutsche Bank emphasizes that the German retail banking market is too

fragmented to be highly profitable and that Deutsche Bank does not seek to

compete on the price level but defines itself through performance quality and

consultancy63

Commerzbank is the second largest private commercial bank in Germany After the

acquisition of Dresdner Bank in 2009 Commerzbank now serves more than 12

million clients (of these 11 million private and one million corporate clients) and

pursues the goal of becoming the market leader in Germany64

UniCredit Bank AG with the brand name Hypovereinsbank (HVB) is a subsidiary

of UniCredirSpA and is the third largest private commercial bank in Germany

HVB serves approximately four million clients predominantly in north Germany

and in Bavaria As its retail banking segment could only report marginal profits in

2009 speculation about a sale or acquisition in this segment has come up As the

Swedish SEB (Skandinaviska Enskilda Bank) is considering selling its German

retail segment with 174 branches and one million clients experts now regard HVB

as a major buying candidate65

61 Schwarzbauer (2009) 62 Kreiler (2008) 63 Deutsche Bank (2009) 64 Kreiler (2008) 65 Houmlpner and Nagl (2010)

18

ING DiBa AG is a subsidiary of the Dutch ING Group and serves over 6 million

clients In contrast to savings cooperative and the major private commercial

banks ING DiBa is specialized in direct banking which distributes services via

telephone the internet or post instead of through branches In Germany ING

DiBa is the leader in direct banking but there are many other direct banks such

as Comdirect (a subsidiary of Commerzbank) Volkswagen Bank or DAB Bank

(a subsidiary of HVB) Competition takes place not only among direct banks but

also between direct and branch banks For instance many saving banks have

blocked the opportunity for customers of direct banks to withdraw cash from their

automated teller machines As savings banks can only charge Euro 174 for

withdrawals via visa cards they fear that direct banks can gain market share by

offering attractive account options with a convenient wide-area ATM provision66

Targobank (former Citibank Deutschland) was acquired by the French

cooperative bank Creacutedit Mutel and now serves more than 34 million clients in

Germany in 2010 The bank is specialized in private retail customers with

branches and direct banking67

In conclusion the degree of concentration in the German retail banking market is

very low which reduces the overall profitability of this sector for two main

reasons Banks earn higher profits in concentrated markets as they obtain either

monopoly rents (structure-conduct-performance paradigm) or due to high market

shares that are gained by more efficient and profitable banks (efficient structure

hypothesis)68 As retail banking services are largely standardized product

differentiation is low and price differentiation is often the only option As public-

law banks serve other interests than profit maximization existing private banks

and MNBs that want to enter this market have a competitive disadvantage The

low switching costs of clients intensifies competition on the price level and thus

reduces the profitability of the market However brand identification and

customer relationships are also important which decreases the willingness of

clients to switch solely on the basis of price comparison In summary market

structure indicates a very high degree of rivalry among existing competitors

66 Online Financial Times Deutschland (2010) 67 Targobank (2010) 68 Havrylchyk and Jurzyk (2006) p15

19

Industry growth In this section industry growth will be examined in a dynamic

analysis of three relevant market growth indicators the future long-run

development of the German population the historical development of the number

of banks and branches in Germany and the historical development of market-

share allocation in the context of major retail banking activities

In the long-run market growth depends on the future numerical development of

the market`s customers - the German population As the growth of population

through birth and immigration is smaller than its decrease by virtue of the mortality

rate and emigration the Federal Statistical Office in Germany estimates a sharp

decline of the German population

Figure 5 Estimated Development of German Population (in millions)

(Federal Statistical Office 2009)

The Federal Statistical Office predicts that the trend of decline in population since

2003 will continue and intensify Whereas approximately 82 million people lived

in Germany in 2008 only between 65 million (average lower limit of the

population with 100000 immigrants yearly) and 70 million people (average

upper limit of the population with 200000 immigrants yearly) will reside in

Germany in 2060 Furthermore the decreasing number of births and the ageing of

the current strongly represented middle age group will lead to substantial changes

in the age structure of the population From 2008 to 2060 the proportion of people

from 65 to 80 years will increase 15 to 20 and the proportion of people over

80 years of age will increase from 5 to 14 of the population69 The

69 Federal Statistical Office (2009)

Average lower limit

Average upper limit

20

implications of the aging population for banks will be discussed in the comparison

between direct banks and BampM banks in section 66 of this thesis

The second indicator of industry growth deals with the number of banks and bank

branches in the German market The overall number of banks in Germany

decreased from 3785 in 1995 to 2300 in 2006 As retail banking usually depends

on the number branches maintained their development in Germany will be

examined

Figure 6 Development of Total Bank Branches in Germany (own illustration based on Koumlhler2008a)

Savings banks and cooperative banks have reduced the number of branches

significantly Public-sector banks (savings banks state banks etc) with 18757

branches and cooperative banks with 16028 branches in 1998 reduced the

number of branches to 14252 and 12303 respectively in 2006 Moreover the

number of branches of major commercial banks decreased from 19055 in 1998 to

8879 in 2006

The main cause for the decrease of branches is the high fixed costs which can not

be recouped from low-revenue standard products that can also be distributed

through alternative low-cost channels such as the internet70

70 Koumlhler and Land (2008)

67930 6666363186

59929 58546 5693653931

5086847244 45467 44100

40332

0

10000

20000

30000

40000

50000

60000

70000

80000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

21

As a third indicator of industry growth this paper reflects on the allocation of

market share within the retail banking sector in order to indentify trends that may

affect overall market growth This paper will reflect on market share in two major

retail banking segments - savings deposits and loans The German Central Bank

classifies the banking market in terms of savings banks cooperative banks direct

banks and credit banks The latter include universal banks which are private

commercial banks branches of foreign banks regional banks and other private

banks

This section reflects the development of market share regarding short- medium-

and long-term saving accounts and examines the allocation of loans to corporate

clients consumers (consumer loans) private households and self-employed

persons

In the period from 1998 to 2006 the market for medium-term saving deposits with

a cancellation period under three months has been dominated by saving banks (53

market share in 2006) and cooperative banks (29 market share in 2006) In the

same period the market share for long-term saving deposits with a cancellation

period above three months has also continuously been dominated by savings banks

(65 market share in 2006) and cooperative banks (24 market share in 2006)

However with regard to deposits that mature daily direct banks were able to

increase market share from approximately 15 in 1998 to over 15 in 2006

Figure 7 Market share development of saving accounts that mature daily (own illustration based on Deutsche Bundesbank 2007)

000

500

1000

1500

2000

2500

3000

3500

4000

4500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Banks

Cooperative Banks

Savings Banks

Credit Banks

22

From 1998 to 2006 market share for loans for corporate clients has been

continuously dominated by credit banks (53 market share in 2006) and savings

banks (34 market share in 2006) However this data also comprises loans for

medium and large corporations which are not part of the retail banking market

Loans for private households and self-employed persons have predominately been

granted by savings banks (39 market share in 2006) credit banks (30 market

share in 2006) and cooperative banks (25 market share in 2006) though direct

banks were able to gain some market share from 0 in 1998 up to 5 in 2006

Even more significantly direct banks were able to gain over 16 market share in

the segment of consumer loans

Figure 8 Market share development of consumer loans (own illustration based on Deutsche Bundesbank 2007)

Hence the most significant growth indicator of the retail banking market results

from the emergence of direct banks which were able to gain substantial market

share in consumper loans and deposits that mature daily

In conclusion the industry growth analysis indentifies the following growth

indicators Firstly a sharp decrease in the German population in the following

decades will reduce growth and increase industry rivalry Moreover the

demographic change increases the proportion of old people in the population

Secondly the number of branches in Germany is decreasing due to high fixed

costs of branches In order to be profitable in retail banking the existing branches

must serve a large quantity of customers which leads to strong competition

relative to market share Thirdly the development of market share allocation

000

1000

2000

3000

4000

5000

6000

7000

2002 2003 2004 2005 2006

Savings Banks

Cooperative Banks

Direct Banks

Credit Banks

23

indicates that only direct banks have experienced significant growth from 1995 to

2006

Exit barriers From a perspective of Transaction Costs Economics one can argue

that exit barriers in branch banking are high for market participants as branches

and staff are highly specific assets that lose value when used in another situation

To a large extent these assets are locked into the context of retail banking

Moreover public-law banks usually have to serve the population regardless of

whether they are profitable or not In a situation in which a bank continuously

experiences losses staff and branches may be considered as sunk costs and thus

economically `irrationalacute exit barriers However theories suggest that staff and

branches are practically valid exit barriers and cause MNCs to stay in a market71

The high degree of exit barriers intensifies the strong rivalry among existing

competitors

43 Threat of New Entrants

New entrants usually seek to gain market share while applying pressure on prices

and costs and thus increasing the investments necessary to compete An expert

survey conducted by the ZEW emphasizes the importance of entry threat to the

German retail-banking market 6666 of market experts state that new

competitors (eg foreign banks) have an important or a very important impact on

industry rivalry72

In this section the threat of new entrants to existing market participants in the

German retail banking sector is discussed In this regard this section evaluates

legal entry barriers capital requirements the necessity of large scale operations

customer switching costs and incumbency advantages of existing domestic banks

Legal entry barriers are determined by governmental regulations in the German

Banking Act (GBA) and are supervised by the Federal Supervisory Authority73

According to section 32 para 1 (1) GBA companies that intend to pursue

commercial banking transactions or financial services in Germany require written

71 Hill Hwang and Kim (1990) 72 Koumlhler and Lang (2008) 73 Bundesanstalt fuumlr Finanzdienstleistungsaufsicht (2005)

24

permission from the Federal Financial Supervisory Authority ( ldquoBundesanstalt fuumlr

Finanzdienstleistungaufsichtrdquo) The execution of banking transactions or financial

services also exists when the operator has its headquarters or primary residence

abroad but repeatedly targets companies or individuals who have their primary

residence in Germany In order to obtain the permit several requirements are

examined (eg business plan qualified management etc)

Companies from third countries which intend to conduct banking transactions and

provide financial services in Germany must establish a subsidiary (section 32 para

1 in connection with ection 33 para 1 (6) GBA) or a branch (section 32 para 1 in

connection with section 53 GBA) in Germany Companies from third countries can

apply for an exemption according to section 2 para 4 GBA if the company is

supervised utilizing international accounting standards in the home country and the

responsible authority works together with the BaFin According to section 53b

GBA companies of EEA states are allowed to establish branches (section 53b para

2) but are also free to conduct cross-border financial services without a domestic

presence (section 53b para 2a) Section 32 para 1 GBA does not apply to business

that is motivated by the initiative of the domestic individual or enterprise (so called

passive service freedom)

Representations are limited to their representative function and are not allowed to

conduct or initiate any banking business

Capital requirements are low for cross-border lending and and relatively low for

representations With high equity modes such as branches and even more so with

subsidiaries capital requirements are relatively high as capital is required for

building a broad network of facilities and offering credit to customers Capital

requirements for direct banks are relatively low compared with those of BampM

banks

The necessity of large scale operation is related to the competitive advantage of

economies of scale A company that serves the market in the context of larger

quantities benefits from lower cost per unit In retail banking profit is gained by

having a large number of clients It is expensive to build up these numbers and to

establish a distribution network to serve them This necessity relates directly to the

strategy of the bank An acquisition offers a shortcut to these facilities although the

25

costs of integration can be high as well74 A MNB may also decide to target only a

certain geographical area with certain clients and therefore do not have to enter on

a very large scale

Customer switching costs are different for each individual In general customers

can easily change their banks and open a deposit account or apply for a loan at

another bank However they have to compare the different terms for usually small

transactions to evaluate the convenience of having a bank nearby and then to

decide to terminate the relationships with their current bank75

Finally the incumbency advantages of existing banks are important entry barriers

In particular they include established brand reputation possession of the most

favorable geographical locations and market knowledge Moreover established

banks may already have exclusive contracts with SMEs76

To conclude legal entry barriers are low and particularly low for banks from the

EEA Capital requirements for entering the market are high yet as far as equity

entry modes are concerned direct banks require relatively low capital as they

distribute their services through low-cost channels Banks need to attract many

customers to be profitable but banks strategy dictates whether or not to entrance

should occur on a large scale Moreover the incumbency advantages of existing

banks constitute important entry barriers

44 Threat of Substitute Products or Services

A substitute in retail banking is a service that offers an attractive trade-off to a bank

service or product As individuals and small firms do not regularly report financial

information as do large enterprises they rely primarily on bank lending However

there are additional forms of financing in the private equity or dept market77

Many non- and near- banks provide substitute products and services Near-banks or

quasi-banks are suppliers of financial services but are not classified as credit

institutes according to section 1 GBA Near-banks such as insurance companies or

credit card organizations however do provide substitute products or services Non-

74 Hughes and MacDonald (2009) 75 Adams (2002) 76 Adams (2002) 77 Xiaoqin and Terada-Hagiwara (2003)

26

banks such as department store chains catalog companies or car producers also

provide substitute services78 For instance instead of taking out a loan in order to

pay for a product individuals or small enterprises may decide to take on a leasing

contract for a certain asset or small enterprises can obtain a trade credit as well

Individuals may decide on buying products from insurance companies instead of

putting money into a bank account

Another substitute for both direct and BampM banks is the person-to-person (p2p)

lending business a new form of borrowing and lending money that takes place in a

web-based market place In this online platform borrowers are connected to

lenders through an auction-like process in which a lender who bids to provide a

loan for the lowest interest rate will be awarded the loan contract with the

borrower A p2p company mediates between private or company borrowers and

lenders and also executes transactions between the parties similar to the role which

e-bay plays in the trade of commercial goods79 The p2p lending business does not

involve traditional banks and thus can offer superior interest rates to borrowers and

higher returns for lenders

45 Bargaining Power of Suppliers

When a supplier group is more concentrated than the industry does not primarily

depend on the industry and when the industry faces high switching costs the

supplier group has strong bargaining power and can reduce the profit potential of

an industry In the retail banking market the most relevant suppliers include human

resources suppliers of capital resources and suppliers of information and

communication technology (ICT)80 Highly talented or experienced specialists are

strongly canvassed and have strong bargaining power with respect to their salary

and working conditions However in the aftermath of the financial crisis many

banks are planning a reduction of staff According to a study of Ernst amp Young

every fifth bank intends to decrease staff and only every 10th bank is planning an

increase81 Given the current situation of the employment market the bargaining

power of employees is relatively low Suppliers of highly specialized banking ICT

78 Gabler Wirtschaftslexikon (2010) 79 Deloitte (2009) p 12 80 Buumlschgen and Boumlrner (2003) 81 Ernst amp Young (2009)

27

solutions have strong bargaining power as switching costs for these systems are

very high Moreover the higher yield requirements of shareholders can be

interpreted as supplier power

46 Bargaining Power of Buyers

In retail banking there are many buyers with relatively low transaction volumes

which weakens their bargaining power However retail banking services are

standardized and buyers can easily find similar services Switching costs have

usually been relatively high for these low volume transactions but in the age of the

internet the market is very transparent and buyers can screen different offerings

more easily This does not necessarily imply that the cheapest banking service will

be chosen automatically as customers also seek a trustworthy brand especially in

times of financial crisis Moreover there are other factors that affect the switching

cost of the individual such as the location of the branch Yet there is a tendency

towards the increasing bargaining power of buyers

This is also substantiated by the ZEW survey 7984 of market experts state that

decreasing customer loyalty and increasing price sensibility are important or very

important factors with respect to the intensity of competition in the German retail

banking sector A comparison of former and modern retail customers also indicates

that the bargaining power of retail banking service users has increased

Former Retail Customer Modern Retail Customer

Passive information seeking

behavior

Active information seeking behavior

Hardy or little informed Good to very good know-how

High customer loyality Increasing willingness to switch

Fixation on the branch Expects multi-channel banking at all times

and places

Little market transparency High price transparency

Relatively undemanding Demanding

Figure 9 Comparison of former and modern retail customers (own illustration based on Swoboda 2004)

28

5 Foreign Bank Entry Strategies in Germany

This section illustrates mode choices for foreign bank entry in Germany Based on

the hierarchical model of market entry modes82 the foreign bank has the choice of

equity and non ndash equity modes of entry An advantage of the hierarchical model is

that it allows comparing between entry modes on different levels The main

difference between equity and non ndash equity modes is the degree of resource

commitment in the foreign country As classified at the beginning of this thesis

non-equity entry refers to international banking and equity entry refers to

multinational banking

The research question of this thesis considers multinational bank entry modes

International banking however is often a first step towards multinational banking

Hence this thesis will also discuss cross-border lending and alliances as non ndash

equity entry modes The following figure illustrates a comprehensive view of

market entry modes for banks

Figure 10 A hierarchical model of entry mode choices for banks (own illustration based on Pan and Tse 2000)

82 Pan and Tse (2000)

Entry Mode Choices

Non - Equity Modes

Export

Cross Border Lending

Contractual Agreements

Alliances

Equity Modes

Equity Joint Ventures

Greenfield Investment

Branch

Subsidiary

Representation

Acquisition

Subsidiary

Branch

29

The hierarchical model illustrates the various entry mode choices for entering the

German retail banking market The creation of a common European financial

market in which banks can integrate freely is a major goal of the European Union83

The previous section of this paper indicates that entry barriers are relatively low

and that the German market is highly competitive Hence the choice of a proper

entry mode which is appropriate to the capabilities and the strategy of the bank is

even more significant Therefore the following section will reflect on the strategic

concept governing the choice of entry modes as well as the proliferation of these

entry modes in the German retail banking market

An international bank that is not interested in investing equity in the foreign

market can enter by means of cross-border lending or by forming a non-equity

alliance These non-equity entry modes can help the bank to access niche markets

or to exploit locational advantages when the bank is located near the German

border

However a retail bank defined in the beginning of this paper as a bank that

`caters for ordinary individuals and small businessacute and that seeks to enter the

German market in order to gain significant revenue from deposits and loan

business might have to consider a physical presence in the foreign country

The analysis considers entry modes that are perceived as international banking

cross-border lending and non-equity strategic alliances Furthermore the equity

modes JVs and representations will be discussed

Subsequently this section compares the market entry of a branch through

Greenfield investment with the market entry of a subsidiary by virtue of

acquisition as these modes of entry are the most common in the German retail

banking market

Finally the following question will be addressed to what extent do demographic

and technical trends favor a direct bank entry mode over a brick and mortar bank

approach in Germany

83 Fidrmuc and Hainz (2008)

30

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks (own illustration)

51 Non ndash equity modes Export ndash Cross-Border Lending

Cross-border lending is equivalent to the export entry mode and is a simple non-

equity strategy to enter a foreign market A bank which participates in cross-

border lending must assess the creditworthiness of the individual borrower as well

as the country risk which involves the possibility that these loans will be impaired

by economic or political proceedings in the foreign country84 The country risk in

Germany is rather low as it is perceived to have a solid political and economic

situation (Country Rating A2) with a stable and a very efficient business

environment (Country Rating A1)85 As a bank will only have limited access to soft

information about the creditworthiness of the borrower the availability of loans

usually decreases and the interest on loans usually increases with distance86 Soft

information for private loans includes the previous experience with the account

management of the credit user environmental facts and a judgment relative to his

employment contract87 For corporate loans soft facts may include the market

environment corporate structure management a business plan as well as

84 Hughes and McDonald (2003) 85 Online wwwtrade-safelycom (2009) 86 Agrawal and Hauswald (2007) 87 Dizil (2009)

Entry Mode Choices of MNBs

Greenfield Investment

Branch

Brick and Mortar Bank Direct Bank

Acquisition

Subsidiary

Brick and Mortar Bank Direct Bank

III

IV

Acknowledgements

Foremost I thank my parents for supporting and encouraging me to pursue this degree

Moreover I would like to thank my brother Marc for his direction and assistance In

particular Marc`s recommendations and suggestions have been invaluable for my

studies and this thesis

In addition I would like to thank Professor Josef Windsperger who provided scientific

support to make this work possible

I would also like to thank Bennett Schwartz Director of International Banking at TD

Bank who gave me the opportunity to work in his department and sparked my interest

in the theme of this thesis

Last but not least special thanks should be given to my student colleagues who helped

me in many ways In particular I thank Urszula Gudacz who has been an exceptional

friend and a great support during my years of study

V

VI

Table of contents

List of Figures VIII

List of Abbreviations IX

1 Introduction 1

11 Research Objective 2

12 Structure 2

2 Classification of Banks 5

21 Bank 5

22 Direct Bank 5

23 Brick and Mortar Bank 6

24 Multinational Bank 6

25 Retail Bank 6

3 Market Entry Theories and Strategies 7

31 Transaction Costs Theory 7

32 Eclectic Theory 8

33 Strategy of Defensive Expansion 10

34 Strategy of Offensive Expansion 11

4 Structure Analysis German Retail Banking Market 12

41 Porter`s Five Forces 12

42 Rivalry Among Existing Competitors 14

43 Threats of New Entrants 23

44 Threats of Substitutes 25

45 Bargaining Power of Suppliers 26

46 Bargaining Power of Buyers 27

5 Foreign Bank Entry Strategies in Germany 28

51 Cross-border lending 30

52 Alliances 31

VII

53 Joint Ventures 32

54 Representations 33

55 Entry Mode Choice Greenfield-Branch vs Acquisition-Subsidiary 34

56 Business Model Choice Direct Bank vs Brick and Mortar Bank 38

561 Demographical Trends 40

562 Technological Trends 42

6 Case Study ING DiBa 45

61 Corporate Profile ING Group 45

62 Market Entry and Market Penetration 45

63 SWOT Analysis 46

64 ING DiBa SWOT Analysis 48

641 Strengths 48

642 Weaknesses 48

643 Opportunities 49

644 Threats 49

65 The Service Marketing Mix 50

66 ING DiBa Marketing Mix (7Ps) 52

67 Summary 55

7 Conclusion 56

Literature

Appendix

VIII

List of Figures

Figure 1 Classification of retail banking clients 6

Figure 2 Michael E Porter`s Five Forces model 12

Figure 3 Structure of the German banking sector 15

Figure 4 Customers of German banks at the end of 2007 (in millions) 16

Figure 5 Estimated development of the German population (in millions) 19

Figure 6 Development of total bank branches in Germany 20

Figure 7 Market share development of accounts that mature daily 21

Figure 8 Market share development of consumer loans 22

Figure 9 Comparison of former and modern retail banking customers 27

Figure 10 A hierarchical model of entry mode choices for banks 28

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks 30

Figure 12 Development of foreign MNBs branches in Germany 35

Figure 13 Development of foreign MNBs subsidiaries in Germany 37

Figure 14 SWOT analysis 47

Figure 15 Service Marketing Mix 51

IX

List of abbreviations

ATM Automated Teller Machine

BampM Brick and Mortar

CEE Central and Easter European

EEA European Economic Area

FDI Foreign Direct Investment

GBA German Banking Act

ICT Information and Communication Technology

JV Joint Venture

MNB Multinational Bank

MNE Multinational Enterprise

RDC Remote Deposit Capture

SMEs Small and Medium Sized Enterprises

TCE Transaction Costs Economics

WOS Wholly Owned Subsidiary

ZEW Centre for European Economic Research

1 Introduction

In the aftermath of the recent financial crisis1 and in times in which banks

rediscover the private individual ndash also described as the renaissance of retail

banking2 - significant attention is now being paid to the market entries of foreign

multinational banks3

The German retail banking market is highly competitive Private cooperative and

state-controlled savings banks compete intensely for market share with hardly any

cooperative activities among the groups As savings banks are owned by German

states towns or local authorities they are protected by law from takeovers by

institutes from the other banking sectors4 Due to the high fragmentation of the

German market hardly any bank has dominant market power The five largest

banks have a total market share of only 20 percent and new competitors enter the

market and attract customers with aggressive price differentiation offers5 The

strong competition among private banks savings banks and co-operative banks

results in low profit margins by international comparison The profit potential in

German private-customer business has fallen for many years From 2000 to 2006

total income from the financial service providers in Germany measured by the

distribution of financial products with private customers fell approximately 15

from euro 675 billion to euro 574 billion6 Though the retail banking sector has

experienced some increase in profits due to cost reduction and reduced loan

failures in 2007 market potential still stagnated in 20097

Since the financial crisis has raised the awareness of the threats of investment

banking many banks have refocused on core business activities in order to

maintain their solvency through increased account deposits Banks need money to

grant loans to private individuals or enterprises provide investment opportunities

finance consumer goods or simply realize baking transactions Yet the recent

financial crisis caused distrust among the banks and loans will not be granted as

1 Plickert (2009) 2 Deutsche Bank (2009) 3 Koumlhler and Lang (2008) 4 Spiegel Online (2007) 5 Welp (2009) 6 Zebrolfesschierenbeckaccosiates (2008) 7 McKinsey amp Company (2007) Zebrolfesschierenbeckaccosiates (2008)

2

easily as before On the consumer side the financial crisis has increased the

demand for secure money investments A survey of 230 highly ranked managers

from private savings and co-operative banks on the effects of the crisis on their

business indicates that banks have concentrated more intensively on business with

private customers both during and after the latest crisis Moreover customer

demand for certificates company shares or funds has fallen significantly while the

demand for standard retail banking products such as call money accounts or

account books has increased substantially8

In spite of its high competitiveness and low profit margins the German retail

banking market is still attractive for foreign banks Foreign MNBs are increasingly

able to penetrate the market for private individuals9 In particular they gain market

share through new products decreasing prices standardized processes and

innovative marketing whereas domestic banks have often relied on continued

customer loyalty10 Although foreign multinational banks in Germany have usually

concentrated on large domestic corporations engaged in international

transactions11 they now enter the market for private and small corporate clients as

well12- a trend that has been supported by the development of internet technology

and other new marketing - channel options

The distinctive characteristics of the German banking market raise several

questions concerning both entry mode and business model considerations of

multinational banks Should a multinational bank engage in cross-border lending or

rather enter the market via foreign direct investment How do the development of

economic political-legal and social-cultural factors in the German market affect a

multinational bank`s entry mode and business model choice

This thesis distinguishes between the non - equity entry modes of cross-border

lending and alliances as well as the equity entry modes of representative offices

branches subsidiaries and JVs both from a Greenfield investment and an

acquisition point of view Each of these organizational entry mode forms has

8 Welp (2009) 9 Reitz (2005) 10 McKinsey amp Company (2007) 11 Hersh and Weller (2002) 12 Koumlhler (2008)

3

distinctive advantages and disadvantages Hence the main focus of this thesis is to

provide a broad understanding of the distinctive market entry and penetration

strategies in light of macro and micro economical developments in Germany

11 Research Objective

This thesis examines entry mode choice decisions and business model

considerations of multinational banks entering the German retail banking sector

The objective is to evaluate the affect of current market developments on their

entry mode decisions

In light of the financial crisis and the banks` rediscovery of the private individual

the German banking sector is currently experiencing a renaissance resulting in

increasing industry rivalry At the same time the processing of bank transactions

and customer services is becoming increasingly independent of the branch

distribution channel and the adoption of new technologies is substantially affecting

the allocation of retail banking services13 The technological evolution is

exemplified by the emergence of web-based direct banks which have been able to

penetrate the retail banking market with low-cost structures innovative ideas and

distinctive service thinking

Eventually the growing importance of the internet and other technological means

as distribution channels on the one hand and the remaining strong demand for

personal consultation on the other hand require a customer-oriented multi-channel

management of the banks14

This paper contrasts the two opposing ends in the field of retail banking

distribution channels It simplifies the entry mode choice between direct banks that

solely operate through the internet and brick amp mortar banks which solely operate

through a branch network Furthermore it differentiates between branch entry via

Greenfield investment and subsidiary entry via acquisition

Two major questions will be addressed

13 Deloitte (2010) 14 Welp (2009)

4

Firstly to what extent do demographic and technical developments favor a direct

bank entry mode over a brick and mortar bank approach in Germany

Secondly what affects the decision in favor of a branch entry mode via Greenfield

investment as compared to a subsidiary entry mode via acquisition in Germany

12 Structure

This thesis is systematically divided into two different complexes - a theoretical

and a practical After a classification of essential banking terms in the section 2

Section 3 then describes relevant market entry theories ndash namely the Transaction

Costs Theory and the Eclectic Theory as well as market entry strategies ndash namely

the offensive and the defensive strategies of expansion

In section 4 the German retail banking market is analyzed within the five forces

framework The goal of this examination is to evaluate market attractiveness and to

identify micro and macroeconomic developments that may shape the market in the

future

Given the theoretical framework of section 3 and the knowledge of industry

structure and trends of section 4 section 5 explores the decision driving factors of

entry mode choice In this section cross-border lending alliances joint ventures

and representations will be discussed Furthermore this section indicates what

affects the decision in favor of a branch entry mode via Greenfield investment as

compared to a subsidiary entry mode via acquisition and to what extent

demographic and technical developments favors a direct bank entry mode over a

brick and mortar bank entry mode in Germany

Section 6 introduces the SWOT analysis as well as the Service Marketing Mix and

applies these concepts to the ING - DiBa case study It illustrates how ING- DiBa

penetrated the German retail banking market with both the implementation of the

direct banking business model and the exploitation of external opportunities

Finally this thesis concludes with a summary of the major findings

5

2 Classification of Banks

21 Bank

This paper refers to banks as defined in the German Banking Act Section 1 GBA

defines financial institutes as enterprises which pursue banking transactions

insofar as the extent of these transactions requires commercial business operations

At least one of the following transactions has to be carried out security

transactions credit transactions payments transactions or other banking business

The enterprise which pursues banking transactions in Germany requires the

permission of the BaFin (Federal Institution for Finance Service Supervision)

according to section 32 GBA

22 Direct Bank

Direct banks are credit institutes which operate without a branch network and

utilize the internet and the telephone as direct communication channels through

which banking transactions are realized and marketing and customer service takes

place Thus direct banks establish cost advantages which they usually transmit in

the form of attractive terms15

23 Brick and Mortar Bank

A brick and mortar (BampM) company is a traditional street-side business that

deals with its customers face to face in an office that the company owns or rents16

A brick and mortar bank serves consumers in a physical facility as distinct from

providing online or telephone services only The term brick and mortar is not a

generally valid classification of a bank but in the jargon of e-commerce it is

frequently employed to distinguish from internet based enterprises In this thesis

the term brick and mortar bank is employed to differentiate between a direct bank

that operates through direct channels and one which operates solely through its

branch network The term brick and mortar is also distinguished from the term

click and mortar which is an expression for a form of multi-channel retailing in

15 Deutsche Bundesbank (2010) 16 Investopedia Dictionary (2010)

6

which both electronic distribution channels (click) and physical premises (mortar)

are utilized17

24 Multinational Bank

Multinational banks are defined as banks that have a physical presence in more

than one country In contrast international banks engage in cross-border operations

but do not establish a physical presence in foreign countries18

25 Retail Bank

There is no generally valid classification of retail banking in theoretical literature

or in practice19 A distinction in retail banking is often made with regard to its

target clientele In this regard some authors define retail banking as the offering of

banking and financial services to individuals and small and medium sized

enterprises20 Other sources define retail banking as the provision of these services

solely to individuals21 This paper employs the following classification of retail

banks `A retail bank is a bank that caters for ordinary individuals and small

business as distinct from large corporations Retail banking operations offer

deposit facilities lend money transfer funds and are prepared to deal in relatively

small amounts`22 In contrast to private and corporate banking retail banking

considers private clients with low to average income as well as small corporate

clients

2

Figure 1 Classification of retail banking clients

(own illustration based on Swoboda 2004)

17 Gabler Wirtschaftslexikon (2010) 18 Hersh and Weller (2002) 19 Muumlller and Joumlhnk (2005) 20 Pond (2007) FinanceWiki (2008) Tremblay and Tremblay (2007) 21 Frei Harker and Hunter (1998) Online Businessdictionarycom (2010) Investoglossarycom (2010) 22 Essvale Corporation Limited (2007)

Retail Banking

Medium and large corporate clients

Wealthy private clients

Small Corporate clients

Private clients

7

3 Market Entry Theories and Strategies

31 Transaction Costs Theory

In the transaction cost theory developed by Ronald Coase and Oliver E

Williamson a comparison of transaction costs determines the optimal form of

organization In TC Theory the entry mode decision is a tradeoff between the

control and the costs of resource commitment Entry modes vary in three major

aspects the cost of resource commitment control as the level of ownership and

environmental risks that may affect the committed resources Hence high-control

modes increase both risk and the potential return23

Williamson differentiates between ex-ante and ex-post transaction costs

Information and searching costs are incurred ex-ante in the process of collecting

market information and identifying suitable partners Negotiation and contract

costs arise ex-ante due to negotiations legal advisory and the determination of

contractual terms Monitoring costs develop ex-post for activities which serve to

control contractual obligations Conflict and enforcement costs arise ex-post due to

the different interpretation of the contract and the costs of enforcing contractual

regulations with sanctions negotiations or through court proceedings Adaption

costs are incurred due to ex-post changes in contractual agreements that become

necessary because of unpredictable developments24

TCE assumes the existence of bounded rationality and opportunism Bounded

rationality describes the limitation in human processing of information and the

planning of possible outcomes Opportunism describes the notion that humans may

act in a self-interested manner by manipulating information and being dishonest

The consequences of these assumptions are incomplete contracts and moral

hazards25 Vice versa opportunism occurs because firms can not write complete

contracts

The size of the transaction costs is determined in each case by the characteristics of

asset specificity uncertainty and frequency Asset specificity arises when the actor

in the market undertakes specific investments in order to fulfill his contractual 23 Chen and Mujtaba (2007) p322 24 Kieser and Ebers (2006) p278 25 Magill and Quenzii (1996) p11

8

obligations It refers to the degree to which long-lasting human or physical assets

are bound in a specific relationship and thus to the extent to which they provide

value in the context of a different situation26 In TCE markets can hardly solve the

problems that high uncertainty creates in combination with bounded rationality and

threats of opportunism Uncertainty includes environmental and behavioral

uncertainty Environmental uncertainty refers to political legal cultural and

economic uncertainties that may affect the success of business transactions

Behavioral uncertainty states that bounded rationality and the threat of opportunism

result in the high costs of monitoring a partner company27 If the similar

transactions are repeated frequently learning effects and economies of scale occur

and will reduce the transaction costs

32 Eclectic Theory

The eclectic theory28 (or OLI paradigm) was developed by John Dunning and is a

framework that merges different economic theories which explain foreign market

entry patterns of multinational corporations29 It states that the internationalization

of MNCs is determined by three sets of independent variables ownership

advantages (or firm- specific advantages) location advantages (or country specific

advantages) and internationalization advantages

The ownership advantage considers the competitive advantages of MNCs arising

from firm-specific characteristics such as size monopoly power economies of

scale management brand name technology and other resource capabilities30

These advantages are usually intangible assets and can be transferred at low costs31

The greater the competitive advantage of the MNC is the more likely it is able to

start or to increase its foreign production32

The location advantages arise from country specific benefits that can be divided

into three categories Firstly a host country may have economic advantages

comprising qualitative and quantitative factors such as production transports costs

26 Dietrich (1994) p18 27 Brouthers and Brouthers (2003) p1183 - 1185 28 Dunning (1980) Dunning (1988) Hill Kwang and Kim (1990) 29 Dunning (2002) 30 Forsbaeck and Oxelheim (2004) 31 Griffin and Pustay (2006) 32 Dunning (2002)

9

communication costs market size or tax incentives Secondly a host country may

offer political advantages in particular governmental policies that may influence

market entry Thirdly a host country may provide social and cultural advantages

including the psychic distance between the foreign and the domestic country as

well as language or cultural aspects that may have an impact on the market entry

decision The higher the attractions of the specific location the more likely it is that

MNCs will exploit their ownership advantage by entering the foreign market33

Because of the existence of transactions costs the internationalization incentive

advantage states that it must be profitable for the MNC to exploit these advantages

itself rather than through local companies (eg licensing)34

In economic literature the OLI paradigm has also been applied to the banking

sector In this regard ownership advantage may include easy access to a vehicle

currency Locational advantages may include country-specific regulations and

entry barriers Internationalization advantages can be information advantages and

access to local deposit bases35

Many empirical studies on the banking market have utilized the eclectic paradigm

as a basic framework For example a study of bank entry into CEE markets

concludes that the ownership advantages of foreign MNBs are strong compared to

banks in emerging markets and especially when the foreign country experiences a

banking crisis36 An application of the OLI paradigm to the Spanish banking

market has shown that bank size and multinational experience of MNBs favor

stronger commitment in the foreign country whereas distance is an entry barrier37

However theoretical literature also states that in service industries clients close to

the MNBs headquarters may be served from this location whereas clients in distant

markets require a physical presence of the MNB in the foreign country which

favors a foreign market entry with increasing distance38

33 Dunning (2002) 34 Hagen (1997) 35 Yannopoulus (1983) 36 Uiboupin and Sorg (2006) 37 Blandoacuten (1998) 38 Blondoacuten (1998) Terpstra and Yu (1988)

10

33 Strategy of Defensive Expansion

A common approach employed to explain the expansion of MNBs involves the

theory of defensive expansion which is also referred to as the acutefollow-the-

customeracute argument

This theory states that MNBs expand abroad in order to provide services for

domestic clients which are often large enterprises that have entered a foreign

market39 The provision of financial services in the foreign country usually requires

a presence at important economic centres Hence to some degree expanding

corporations impose pressure on their domestic banks to follow-up40

The term acutedefensiveacute is derived from the idea that a failure to expand may lead to a

loss of the client not only in the foreign country but also in the domestic one as

the client may associate with a foreign MNB41 Consequently MNBs which pursue

this strategy seek to prevent losses rather then to generate new profits in the foreign

market42 Furthermore the domestic bank has an incomparable competitive

advantage over banks in the foreign country with regard to the knowledge of

customer needs the respective risk of credit default as well as an interest in cross-

selling products such as financial advisory43

Due to earlier business relationships with the client the domestic bank has reduced

costs for examining the financial capacities of the respective enterprise and thus

can offer cheaper services44 Most foreign entry evidence supports the defensive

expansion theory45

A study on this theory with respect to retail banking has revealed that MNBs

sometimes expand abroad in order to provide banking services to specific

communities46

39 Trend im retail-banking koumlhler 40 Henneberger and Graf (2000) 41 Mullineux and Murinde (2003) 42 Naaborg (2007) 43 Knoop (2006) 44 Bhattacharya (1994) 45 Bhattacharya (1994) Naaborg (2007) 46 Tschoegl (1987)

11

34 Strategy of Offensive Expansion

MNBs that offensively expand abroad primarily seek to increase their customer

base both in the home and in the foreign country Firstly the establishment of

foreign branches and subsidiaries enables the MNB to expand their services to

domestic residents who benefit from the international orientation of the bank

These may include customers that have business partners in the foreign country

Secondly MNBs may target new customers in the foreign country in particular

MNEs or foreign subsidiaries of domestic enterprises As the MNB must in both

cases entice customers away from other banks the MNB has to offer attractive and

competitive conditions for their financial services47

47 Buumlschgen (1998) p604

12

4 Industry Analysis German Retail Banking Sector

41 Porter`s Five Forces

In the school of Industrial Economics the five-forces model has established itself

as a core element of industry analysis Porter`s analysis framework is built on the

following five market forces that shape the strategy of competitors threat of new

entrants threat of substitute products or services bargaining power of buyers and

suppliers as well as rivalry among existing competitors

Porterrsquos concept is based on the knowledge that the strategy of an enterprise must

orient itself to its market environment whereby the competitive strategy arises

from a differentiated understanding of the market structure and the knowledge of

how it changes The effects of these forces determine the intensity of the

competition in a market and with it its profitability and attractiveness Therefore

the aim of the enterprise strategy should be reflected in the search for possibilities

for the reduction or use of these competitive forces relative to its own enterprise In

this regard Porter`s model is conducive to the analysis of the driving forces

working in the respective industry

Figure 2 Michael E Porter`s five forces model (Own illustration based on Porter 1979)

Industry Rivalry

Threat of New

Entrants

Bargaining Power of

Buyers

Threat of Substitute Products

and Services

Bargaining Power of Suppliers

13

Porter`s framework is a useful and frequently utilized analytical tool to describe the

foundations of industry competition

A high degree of rivalry among the existing enterprises leads to high competitive

pressure and can lower profit margins and the profitability of individual

enterprises In situations in which a large number of enterprises target similar

market segments with comparable strategies in which the market grows slowly

price is the most important differentiation factor and high exit barriers exist a

negative impact on the industryrsquos profitability is effected48

The threat of new entrants can be determined by the entry barriers of a market The

competitive pressure on existing enterprises increases with low entry barriers In

such a situation important elements of the market (eg shares of the market price

level) can change due to the entry of new market participants49

The bargaining power of buyers determines to what extent customers can influence

enterprises by the amount of consumption and the pressure on margins Important

indexes of a high degree of buyer power include high fixed costs in the industry

existence of supplements of the product or service high degree of customer

concentration customers` knowledge of production costs possibility of a reverse

integration of customers high growth rates of the market and a strong

individualization of customer demand50

The bargaining power of suppliers affects industry profitability if for example a

concentrated supplier group dominates over existing enterprises in the market

which are not important buyers for the suppliers Then the industry faces high

margin pressure by the suppliers

A threat of substitute products and services exists in particular if cheaper or higher-

quality products and services are able to reduce existing sales volumes of a market

or an enterprise51 The future sales potential of existing enterprises becomes limited

and industry competition increases

48 Porter (1985) 49 Porter (1979) Recklies (2001) 50 Recklies (2001) 51 Recklies (2001)

14

Critics of this model state that it neglects the impact of complements as a sixth

force of the industry since they may facilitate or hinder the commercialization of

certain goods However Porter argues that complements are not a force itself but

they affect profitability in the way that they influence the five forces and that `the

strategist must trace the positive or negative influence of complements on all five

forces to ascertain their impact on profitability`52

One limitation of this model is based on studies which indicate that company-

specific factors may have a more important impact on profit than industry forces53

Furthermore the model suggests relatively static and stable market structure which

makes it difficult to assess contemporary dynamic markets54

The model does not assess the impact of the parent company on its subsidiary

which is especially important in the banking sector in which parent companies

often have a strong impact on the performance of their subsidiary or branch The

parenting advantage includes the stand-alone influence through monitoring and

influence on management decisions or capital expenses Furthermore parents

create value by enhancing synergies within the group offering corporate functions

or managing portfolios55

42 Rivalry among existing competitors

In this section the intensity of competitive rivalry among existing competitors in

the German retail banking sector is discussed In this regard an analysis of industry

structure industry growth and exit barriers will be conducted

Industry structure The German banking market is characterized by a three-pillar

system which is reflected by the strict distinction between public-law banks

cooperative banks and private banks56 Each pursues different goals and is subject

to different regulations Private commercial banks pursue the goal of profit

maximization whereas saving banks serve the public contract of offering secure

52 Porter (1997)p11 53 Zack (1999) 54 Recklies (2001) 55 Goold Cambpell and Alexander (1994) 56 Gramlich (2005)

saving possibilities and loans C

interest of their members

banking market is structured as follow

Figure 3(own illustration based on Sch

Public-law banks including saving banks and state banks

total balance sheet volume of banks in Germany

do not participate in retail banking The cooperative bank sector amounts to 11

the total including cooperative banks

cooperative central banks

commercial banks including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

31 of total balance sheet volume

European Research (ZWE) 43 of experts state that the three

important or very important and

for the low number of cross

In order to describe industry rivalry among maj

retail sector the following table illustrates the number of customers per bank in

Germany

57 Engerer (2006) 58 Koumlhler (2008b)

banks 24

Private commercial banks 31

15

possibilities and loans Cooperative banks primarily serve the economic

interest of their members57 In terms of total balance sheet volume the German

banking market is structured as follows

Figure 3 Structure of the German Banking Sector(own illustration based on Schrooten 2009)

law banks including saving banks and state banks amount to 33 of the

total balance sheet volume of banks in Germany However state banks

do not participate in retail banking The cooperative bank sector amounts to 11

including cooperative banks which participate in retail ban

cooperative central banks which primarily serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

alance sheet volume According to a recent survey of the Center for

European Research (ZWE) 43 of experts state that the three-pillar system is

important or very important and 33 state that it is the critical factor responsible

cross-border mergers and acquisitions in Germany

In order to describe industry rivalry among major banks that participate in the

the following table illustrates the number of customers per bank in

Savings banks 13

State banks 20

Cooperative central banks

3Credit cooperative banks 8

Other banks 24

serve the economic

sheet volume the German

Structure of the German Banking Sector

amount to 33 of the

However state banks generally

do not participate in retail banking The cooperative bank sector amounts to 11 of

participate in retail banking and

serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks amount to

According to a recent survey of the Center for

pillar system is

33 state that it is the critical factor responsible

border mergers and acquisitions in Germany58

or banks that participate in the

the following table illustrates the number of customers per bank in

State banks 20

Cooperative central banks

16

Figure 4 Customers of German Banks at the end of 2007 in millions (own illustration based on Deutsche Bank 2008)

With approximately 50 million customers savings banks are the market leader in

the German retail banking sector Although state liability assumption for savings

banks was abolished in 2005 because the EU saw in it an unacceptable subsidy to

the disadvantage of private banks customers still associate the name `Sparkasse`

with state guarantees The specific characteristic of a saving bank is based on its

public contract in that it has to accept customers with poor credit-worthiness that

profits should be used to enhance public wealth and that the middle class should be

supplied with loans59

With approximately 30 million customers cooperative banks are the second major

player in the German retail banking sector Nearly half of these customers are

members of the cooperative banks60 In contrast to the profit maximization goal of

private commercial banks their aim is to fund their members and secure their

economic independence Although cooperative banks are economically and legally

independent in the different regions they appear uniformly as a group under the

brand of ldquoVolks- und Raiffeisenbankenrdquo With regard to growth in customer base

cooperative banks benefit from the advantage of having the regional flexibility that

59 Kruck (2008) 60 Online Raiffeisen Bank Homepage

31

4

61

118

242

30

50

0 10 20 30 40 50 60

Citibank

Hypovereinsbank

ING DiBa

Commerzbank and Dresdner Bank

Postbank and Deutsche Bank

Credit Unions (Volksbanken)

Savings Banks (Sparkassen)

17

allows for topical advertisement as well as a centralized management focus on

improving reputation61

The third group comprises the major private commercial banks including Deutsche

Bank Postbank Commerzbank and Hypovereinsbank Deutsche Bank is a leading

multinational investment bank but with relatively low market share in the retail

banking market Deutsche Bank (97 million clients) is acquiring Postbank (145

million clients) with its broad branch network in a three-step process Together

they have 242 million clients However Heino Ruland from the analyst company

Frankfurt Finanz Partner argues that Deutsche Bank might not be able to capitalize

on the financially weaker Postbank clients as Deutsche Bank is specialized in

corporate clients62 With regard to rivalry intensity and market profitability Rainer

Neske supervisory board member and head of private amp business clients of

Deutsche Bank emphasizes that the German retail banking market is too

fragmented to be highly profitable and that Deutsche Bank does not seek to

compete on the price level but defines itself through performance quality and

consultancy63

Commerzbank is the second largest private commercial bank in Germany After the

acquisition of Dresdner Bank in 2009 Commerzbank now serves more than 12

million clients (of these 11 million private and one million corporate clients) and

pursues the goal of becoming the market leader in Germany64

UniCredit Bank AG with the brand name Hypovereinsbank (HVB) is a subsidiary

of UniCredirSpA and is the third largest private commercial bank in Germany

HVB serves approximately four million clients predominantly in north Germany

and in Bavaria As its retail banking segment could only report marginal profits in

2009 speculation about a sale or acquisition in this segment has come up As the

Swedish SEB (Skandinaviska Enskilda Bank) is considering selling its German

retail segment with 174 branches and one million clients experts now regard HVB

as a major buying candidate65

61 Schwarzbauer (2009) 62 Kreiler (2008) 63 Deutsche Bank (2009) 64 Kreiler (2008) 65 Houmlpner and Nagl (2010)

18

ING DiBa AG is a subsidiary of the Dutch ING Group and serves over 6 million

clients In contrast to savings cooperative and the major private commercial

banks ING DiBa is specialized in direct banking which distributes services via

telephone the internet or post instead of through branches In Germany ING

DiBa is the leader in direct banking but there are many other direct banks such

as Comdirect (a subsidiary of Commerzbank) Volkswagen Bank or DAB Bank

(a subsidiary of HVB) Competition takes place not only among direct banks but

also between direct and branch banks For instance many saving banks have

blocked the opportunity for customers of direct banks to withdraw cash from their

automated teller machines As savings banks can only charge Euro 174 for

withdrawals via visa cards they fear that direct banks can gain market share by

offering attractive account options with a convenient wide-area ATM provision66

Targobank (former Citibank Deutschland) was acquired by the French

cooperative bank Creacutedit Mutel and now serves more than 34 million clients in

Germany in 2010 The bank is specialized in private retail customers with

branches and direct banking67

In conclusion the degree of concentration in the German retail banking market is

very low which reduces the overall profitability of this sector for two main

reasons Banks earn higher profits in concentrated markets as they obtain either

monopoly rents (structure-conduct-performance paradigm) or due to high market

shares that are gained by more efficient and profitable banks (efficient structure

hypothesis)68 As retail banking services are largely standardized product

differentiation is low and price differentiation is often the only option As public-

law banks serve other interests than profit maximization existing private banks

and MNBs that want to enter this market have a competitive disadvantage The

low switching costs of clients intensifies competition on the price level and thus

reduces the profitability of the market However brand identification and

customer relationships are also important which decreases the willingness of

clients to switch solely on the basis of price comparison In summary market

structure indicates a very high degree of rivalry among existing competitors

66 Online Financial Times Deutschland (2010) 67 Targobank (2010) 68 Havrylchyk and Jurzyk (2006) p15

19

Industry growth In this section industry growth will be examined in a dynamic

analysis of three relevant market growth indicators the future long-run

development of the German population the historical development of the number

of banks and branches in Germany and the historical development of market-

share allocation in the context of major retail banking activities

In the long-run market growth depends on the future numerical development of

the market`s customers - the German population As the growth of population

through birth and immigration is smaller than its decrease by virtue of the mortality

rate and emigration the Federal Statistical Office in Germany estimates a sharp

decline of the German population

Figure 5 Estimated Development of German Population (in millions)

(Federal Statistical Office 2009)

The Federal Statistical Office predicts that the trend of decline in population since

2003 will continue and intensify Whereas approximately 82 million people lived

in Germany in 2008 only between 65 million (average lower limit of the

population with 100000 immigrants yearly) and 70 million people (average

upper limit of the population with 200000 immigrants yearly) will reside in

Germany in 2060 Furthermore the decreasing number of births and the ageing of

the current strongly represented middle age group will lead to substantial changes

in the age structure of the population From 2008 to 2060 the proportion of people

from 65 to 80 years will increase 15 to 20 and the proportion of people over

80 years of age will increase from 5 to 14 of the population69 The

69 Federal Statistical Office (2009)

Average lower limit

Average upper limit

20

implications of the aging population for banks will be discussed in the comparison

between direct banks and BampM banks in section 66 of this thesis

The second indicator of industry growth deals with the number of banks and bank

branches in the German market The overall number of banks in Germany

decreased from 3785 in 1995 to 2300 in 2006 As retail banking usually depends

on the number branches maintained their development in Germany will be

examined

Figure 6 Development of Total Bank Branches in Germany (own illustration based on Koumlhler2008a)

Savings banks and cooperative banks have reduced the number of branches

significantly Public-sector banks (savings banks state banks etc) with 18757

branches and cooperative banks with 16028 branches in 1998 reduced the

number of branches to 14252 and 12303 respectively in 2006 Moreover the

number of branches of major commercial banks decreased from 19055 in 1998 to

8879 in 2006

The main cause for the decrease of branches is the high fixed costs which can not

be recouped from low-revenue standard products that can also be distributed

through alternative low-cost channels such as the internet70

70 Koumlhler and Land (2008)

67930 6666363186

59929 58546 5693653931

5086847244 45467 44100

40332

0

10000

20000

30000

40000

50000

60000

70000

80000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

21

As a third indicator of industry growth this paper reflects on the allocation of

market share within the retail banking sector in order to indentify trends that may

affect overall market growth This paper will reflect on market share in two major

retail banking segments - savings deposits and loans The German Central Bank

classifies the banking market in terms of savings banks cooperative banks direct

banks and credit banks The latter include universal banks which are private

commercial banks branches of foreign banks regional banks and other private

banks

This section reflects the development of market share regarding short- medium-

and long-term saving accounts and examines the allocation of loans to corporate

clients consumers (consumer loans) private households and self-employed

persons

In the period from 1998 to 2006 the market for medium-term saving deposits with

a cancellation period under three months has been dominated by saving banks (53

market share in 2006) and cooperative banks (29 market share in 2006) In the

same period the market share for long-term saving deposits with a cancellation

period above three months has also continuously been dominated by savings banks

(65 market share in 2006) and cooperative banks (24 market share in 2006)

However with regard to deposits that mature daily direct banks were able to

increase market share from approximately 15 in 1998 to over 15 in 2006

Figure 7 Market share development of saving accounts that mature daily (own illustration based on Deutsche Bundesbank 2007)

000

500

1000

1500

2000

2500

3000

3500

4000

4500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Banks

Cooperative Banks

Savings Banks

Credit Banks

22

From 1998 to 2006 market share for loans for corporate clients has been

continuously dominated by credit banks (53 market share in 2006) and savings

banks (34 market share in 2006) However this data also comprises loans for

medium and large corporations which are not part of the retail banking market

Loans for private households and self-employed persons have predominately been

granted by savings banks (39 market share in 2006) credit banks (30 market

share in 2006) and cooperative banks (25 market share in 2006) though direct

banks were able to gain some market share from 0 in 1998 up to 5 in 2006

Even more significantly direct banks were able to gain over 16 market share in

the segment of consumer loans

Figure 8 Market share development of consumer loans (own illustration based on Deutsche Bundesbank 2007)

Hence the most significant growth indicator of the retail banking market results

from the emergence of direct banks which were able to gain substantial market

share in consumper loans and deposits that mature daily

In conclusion the industry growth analysis indentifies the following growth

indicators Firstly a sharp decrease in the German population in the following

decades will reduce growth and increase industry rivalry Moreover the

demographic change increases the proportion of old people in the population

Secondly the number of branches in Germany is decreasing due to high fixed

costs of branches In order to be profitable in retail banking the existing branches

must serve a large quantity of customers which leads to strong competition

relative to market share Thirdly the development of market share allocation

000

1000

2000

3000

4000

5000

6000

7000

2002 2003 2004 2005 2006

Savings Banks

Cooperative Banks

Direct Banks

Credit Banks

23

indicates that only direct banks have experienced significant growth from 1995 to

2006

Exit barriers From a perspective of Transaction Costs Economics one can argue

that exit barriers in branch banking are high for market participants as branches

and staff are highly specific assets that lose value when used in another situation

To a large extent these assets are locked into the context of retail banking

Moreover public-law banks usually have to serve the population regardless of

whether they are profitable or not In a situation in which a bank continuously

experiences losses staff and branches may be considered as sunk costs and thus

economically `irrationalacute exit barriers However theories suggest that staff and

branches are practically valid exit barriers and cause MNCs to stay in a market71

The high degree of exit barriers intensifies the strong rivalry among existing

competitors

43 Threat of New Entrants

New entrants usually seek to gain market share while applying pressure on prices

and costs and thus increasing the investments necessary to compete An expert

survey conducted by the ZEW emphasizes the importance of entry threat to the

German retail-banking market 6666 of market experts state that new

competitors (eg foreign banks) have an important or a very important impact on

industry rivalry72

In this section the threat of new entrants to existing market participants in the

German retail banking sector is discussed In this regard this section evaluates

legal entry barriers capital requirements the necessity of large scale operations

customer switching costs and incumbency advantages of existing domestic banks

Legal entry barriers are determined by governmental regulations in the German

Banking Act (GBA) and are supervised by the Federal Supervisory Authority73

According to section 32 para 1 (1) GBA companies that intend to pursue

commercial banking transactions or financial services in Germany require written

71 Hill Hwang and Kim (1990) 72 Koumlhler and Lang (2008) 73 Bundesanstalt fuumlr Finanzdienstleistungsaufsicht (2005)

24

permission from the Federal Financial Supervisory Authority ( ldquoBundesanstalt fuumlr

Finanzdienstleistungaufsichtrdquo) The execution of banking transactions or financial

services also exists when the operator has its headquarters or primary residence

abroad but repeatedly targets companies or individuals who have their primary

residence in Germany In order to obtain the permit several requirements are

examined (eg business plan qualified management etc)

Companies from third countries which intend to conduct banking transactions and

provide financial services in Germany must establish a subsidiary (section 32 para

1 in connection with ection 33 para 1 (6) GBA) or a branch (section 32 para 1 in

connection with section 53 GBA) in Germany Companies from third countries can

apply for an exemption according to section 2 para 4 GBA if the company is

supervised utilizing international accounting standards in the home country and the

responsible authority works together with the BaFin According to section 53b

GBA companies of EEA states are allowed to establish branches (section 53b para

2) but are also free to conduct cross-border financial services without a domestic

presence (section 53b para 2a) Section 32 para 1 GBA does not apply to business

that is motivated by the initiative of the domestic individual or enterprise (so called

passive service freedom)

Representations are limited to their representative function and are not allowed to

conduct or initiate any banking business

Capital requirements are low for cross-border lending and and relatively low for

representations With high equity modes such as branches and even more so with

subsidiaries capital requirements are relatively high as capital is required for

building a broad network of facilities and offering credit to customers Capital

requirements for direct banks are relatively low compared with those of BampM

banks

The necessity of large scale operation is related to the competitive advantage of

economies of scale A company that serves the market in the context of larger

quantities benefits from lower cost per unit In retail banking profit is gained by

having a large number of clients It is expensive to build up these numbers and to

establish a distribution network to serve them This necessity relates directly to the

strategy of the bank An acquisition offers a shortcut to these facilities although the

25

costs of integration can be high as well74 A MNB may also decide to target only a

certain geographical area with certain clients and therefore do not have to enter on

a very large scale

Customer switching costs are different for each individual In general customers

can easily change their banks and open a deposit account or apply for a loan at

another bank However they have to compare the different terms for usually small

transactions to evaluate the convenience of having a bank nearby and then to

decide to terminate the relationships with their current bank75

Finally the incumbency advantages of existing banks are important entry barriers

In particular they include established brand reputation possession of the most

favorable geographical locations and market knowledge Moreover established

banks may already have exclusive contracts with SMEs76

To conclude legal entry barriers are low and particularly low for banks from the

EEA Capital requirements for entering the market are high yet as far as equity

entry modes are concerned direct banks require relatively low capital as they

distribute their services through low-cost channels Banks need to attract many

customers to be profitable but banks strategy dictates whether or not to entrance

should occur on a large scale Moreover the incumbency advantages of existing

banks constitute important entry barriers

44 Threat of Substitute Products or Services

A substitute in retail banking is a service that offers an attractive trade-off to a bank

service or product As individuals and small firms do not regularly report financial

information as do large enterprises they rely primarily on bank lending However

there are additional forms of financing in the private equity or dept market77

Many non- and near- banks provide substitute products and services Near-banks or

quasi-banks are suppliers of financial services but are not classified as credit

institutes according to section 1 GBA Near-banks such as insurance companies or

credit card organizations however do provide substitute products or services Non-

74 Hughes and MacDonald (2009) 75 Adams (2002) 76 Adams (2002) 77 Xiaoqin and Terada-Hagiwara (2003)

26

banks such as department store chains catalog companies or car producers also

provide substitute services78 For instance instead of taking out a loan in order to

pay for a product individuals or small enterprises may decide to take on a leasing

contract for a certain asset or small enterprises can obtain a trade credit as well

Individuals may decide on buying products from insurance companies instead of

putting money into a bank account

Another substitute for both direct and BampM banks is the person-to-person (p2p)

lending business a new form of borrowing and lending money that takes place in a

web-based market place In this online platform borrowers are connected to

lenders through an auction-like process in which a lender who bids to provide a

loan for the lowest interest rate will be awarded the loan contract with the

borrower A p2p company mediates between private or company borrowers and

lenders and also executes transactions between the parties similar to the role which

e-bay plays in the trade of commercial goods79 The p2p lending business does not

involve traditional banks and thus can offer superior interest rates to borrowers and

higher returns for lenders

45 Bargaining Power of Suppliers

When a supplier group is more concentrated than the industry does not primarily

depend on the industry and when the industry faces high switching costs the

supplier group has strong bargaining power and can reduce the profit potential of

an industry In the retail banking market the most relevant suppliers include human

resources suppliers of capital resources and suppliers of information and

communication technology (ICT)80 Highly talented or experienced specialists are

strongly canvassed and have strong bargaining power with respect to their salary

and working conditions However in the aftermath of the financial crisis many

banks are planning a reduction of staff According to a study of Ernst amp Young

every fifth bank intends to decrease staff and only every 10th bank is planning an

increase81 Given the current situation of the employment market the bargaining

power of employees is relatively low Suppliers of highly specialized banking ICT

78 Gabler Wirtschaftslexikon (2010) 79 Deloitte (2009) p 12 80 Buumlschgen and Boumlrner (2003) 81 Ernst amp Young (2009)

27

solutions have strong bargaining power as switching costs for these systems are

very high Moreover the higher yield requirements of shareholders can be

interpreted as supplier power

46 Bargaining Power of Buyers

In retail banking there are many buyers with relatively low transaction volumes

which weakens their bargaining power However retail banking services are

standardized and buyers can easily find similar services Switching costs have

usually been relatively high for these low volume transactions but in the age of the

internet the market is very transparent and buyers can screen different offerings

more easily This does not necessarily imply that the cheapest banking service will

be chosen automatically as customers also seek a trustworthy brand especially in

times of financial crisis Moreover there are other factors that affect the switching

cost of the individual such as the location of the branch Yet there is a tendency

towards the increasing bargaining power of buyers

This is also substantiated by the ZEW survey 7984 of market experts state that

decreasing customer loyalty and increasing price sensibility are important or very

important factors with respect to the intensity of competition in the German retail

banking sector A comparison of former and modern retail customers also indicates

that the bargaining power of retail banking service users has increased

Former Retail Customer Modern Retail Customer

Passive information seeking

behavior

Active information seeking behavior

Hardy or little informed Good to very good know-how

High customer loyality Increasing willingness to switch

Fixation on the branch Expects multi-channel banking at all times

and places

Little market transparency High price transparency

Relatively undemanding Demanding

Figure 9 Comparison of former and modern retail customers (own illustration based on Swoboda 2004)

28

5 Foreign Bank Entry Strategies in Germany

This section illustrates mode choices for foreign bank entry in Germany Based on

the hierarchical model of market entry modes82 the foreign bank has the choice of

equity and non ndash equity modes of entry An advantage of the hierarchical model is

that it allows comparing between entry modes on different levels The main

difference between equity and non ndash equity modes is the degree of resource

commitment in the foreign country As classified at the beginning of this thesis

non-equity entry refers to international banking and equity entry refers to

multinational banking

The research question of this thesis considers multinational bank entry modes

International banking however is often a first step towards multinational banking

Hence this thesis will also discuss cross-border lending and alliances as non ndash

equity entry modes The following figure illustrates a comprehensive view of

market entry modes for banks

Figure 10 A hierarchical model of entry mode choices for banks (own illustration based on Pan and Tse 2000)

82 Pan and Tse (2000)

Entry Mode Choices

Non - Equity Modes

Export

Cross Border Lending

Contractual Agreements

Alliances

Equity Modes

Equity Joint Ventures

Greenfield Investment

Branch

Subsidiary

Representation

Acquisition

Subsidiary

Branch

29

The hierarchical model illustrates the various entry mode choices for entering the

German retail banking market The creation of a common European financial

market in which banks can integrate freely is a major goal of the European Union83

The previous section of this paper indicates that entry barriers are relatively low

and that the German market is highly competitive Hence the choice of a proper

entry mode which is appropriate to the capabilities and the strategy of the bank is

even more significant Therefore the following section will reflect on the strategic

concept governing the choice of entry modes as well as the proliferation of these

entry modes in the German retail banking market

An international bank that is not interested in investing equity in the foreign

market can enter by means of cross-border lending or by forming a non-equity

alliance These non-equity entry modes can help the bank to access niche markets

or to exploit locational advantages when the bank is located near the German

border

However a retail bank defined in the beginning of this paper as a bank that

`caters for ordinary individuals and small businessacute and that seeks to enter the

German market in order to gain significant revenue from deposits and loan

business might have to consider a physical presence in the foreign country

The analysis considers entry modes that are perceived as international banking

cross-border lending and non-equity strategic alliances Furthermore the equity

modes JVs and representations will be discussed

Subsequently this section compares the market entry of a branch through

Greenfield investment with the market entry of a subsidiary by virtue of

acquisition as these modes of entry are the most common in the German retail

banking market

Finally the following question will be addressed to what extent do demographic

and technical trends favor a direct bank entry mode over a brick and mortar bank

approach in Germany

83 Fidrmuc and Hainz (2008)

30

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks (own illustration)

51 Non ndash equity modes Export ndash Cross-Border Lending

Cross-border lending is equivalent to the export entry mode and is a simple non-

equity strategy to enter a foreign market A bank which participates in cross-

border lending must assess the creditworthiness of the individual borrower as well

as the country risk which involves the possibility that these loans will be impaired

by economic or political proceedings in the foreign country84 The country risk in

Germany is rather low as it is perceived to have a solid political and economic

situation (Country Rating A2) with a stable and a very efficient business

environment (Country Rating A1)85 As a bank will only have limited access to soft

information about the creditworthiness of the borrower the availability of loans

usually decreases and the interest on loans usually increases with distance86 Soft

information for private loans includes the previous experience with the account

management of the credit user environmental facts and a judgment relative to his

employment contract87 For corporate loans soft facts may include the market

environment corporate structure management a business plan as well as

84 Hughes and McDonald (2003) 85 Online wwwtrade-safelycom (2009) 86 Agrawal and Hauswald (2007) 87 Dizil (2009)

Entry Mode Choices of MNBs

Greenfield Investment

Branch

Brick and Mortar Bank Direct Bank

Acquisition

Subsidiary

Brick and Mortar Bank Direct Bank

IV

Acknowledgements

Foremost I thank my parents for supporting and encouraging me to pursue this degree

Moreover I would like to thank my brother Marc for his direction and assistance In

particular Marc`s recommendations and suggestions have been invaluable for my

studies and this thesis

In addition I would like to thank Professor Josef Windsperger who provided scientific

support to make this work possible

I would also like to thank Bennett Schwartz Director of International Banking at TD

Bank who gave me the opportunity to work in his department and sparked my interest

in the theme of this thesis

Last but not least special thanks should be given to my student colleagues who helped

me in many ways In particular I thank Urszula Gudacz who has been an exceptional

friend and a great support during my years of study

V

VI

Table of contents

List of Figures VIII

List of Abbreviations IX

1 Introduction 1

11 Research Objective 2

12 Structure 2

2 Classification of Banks 5

21 Bank 5

22 Direct Bank 5

23 Brick and Mortar Bank 6

24 Multinational Bank 6

25 Retail Bank 6

3 Market Entry Theories and Strategies 7

31 Transaction Costs Theory 7

32 Eclectic Theory 8

33 Strategy of Defensive Expansion 10

34 Strategy of Offensive Expansion 11

4 Structure Analysis German Retail Banking Market 12

41 Porter`s Five Forces 12

42 Rivalry Among Existing Competitors 14

43 Threats of New Entrants 23

44 Threats of Substitutes 25

45 Bargaining Power of Suppliers 26

46 Bargaining Power of Buyers 27

5 Foreign Bank Entry Strategies in Germany 28

51 Cross-border lending 30

52 Alliances 31

VII

53 Joint Ventures 32

54 Representations 33

55 Entry Mode Choice Greenfield-Branch vs Acquisition-Subsidiary 34

56 Business Model Choice Direct Bank vs Brick and Mortar Bank 38

561 Demographical Trends 40

562 Technological Trends 42

6 Case Study ING DiBa 45

61 Corporate Profile ING Group 45

62 Market Entry and Market Penetration 45

63 SWOT Analysis 46

64 ING DiBa SWOT Analysis 48

641 Strengths 48

642 Weaknesses 48

643 Opportunities 49

644 Threats 49

65 The Service Marketing Mix 50

66 ING DiBa Marketing Mix (7Ps) 52

67 Summary 55

7 Conclusion 56

Literature

Appendix

VIII

List of Figures

Figure 1 Classification of retail banking clients 6

Figure 2 Michael E Porter`s Five Forces model 12

Figure 3 Structure of the German banking sector 15

Figure 4 Customers of German banks at the end of 2007 (in millions) 16

Figure 5 Estimated development of the German population (in millions) 19

Figure 6 Development of total bank branches in Germany 20

Figure 7 Market share development of accounts that mature daily 21

Figure 8 Market share development of consumer loans 22

Figure 9 Comparison of former and modern retail banking customers 27

Figure 10 A hierarchical model of entry mode choices for banks 28

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks 30

Figure 12 Development of foreign MNBs branches in Germany 35

Figure 13 Development of foreign MNBs subsidiaries in Germany 37

Figure 14 SWOT analysis 47

Figure 15 Service Marketing Mix 51

IX

List of abbreviations

ATM Automated Teller Machine

BampM Brick and Mortar

CEE Central and Easter European

EEA European Economic Area

FDI Foreign Direct Investment

GBA German Banking Act

ICT Information and Communication Technology

JV Joint Venture

MNB Multinational Bank

MNE Multinational Enterprise

RDC Remote Deposit Capture

SMEs Small and Medium Sized Enterprises

TCE Transaction Costs Economics

WOS Wholly Owned Subsidiary

ZEW Centre for European Economic Research

1 Introduction

In the aftermath of the recent financial crisis1 and in times in which banks

rediscover the private individual ndash also described as the renaissance of retail

banking2 - significant attention is now being paid to the market entries of foreign

multinational banks3

The German retail banking market is highly competitive Private cooperative and

state-controlled savings banks compete intensely for market share with hardly any

cooperative activities among the groups As savings banks are owned by German

states towns or local authorities they are protected by law from takeovers by

institutes from the other banking sectors4 Due to the high fragmentation of the

German market hardly any bank has dominant market power The five largest

banks have a total market share of only 20 percent and new competitors enter the

market and attract customers with aggressive price differentiation offers5 The

strong competition among private banks savings banks and co-operative banks

results in low profit margins by international comparison The profit potential in

German private-customer business has fallen for many years From 2000 to 2006

total income from the financial service providers in Germany measured by the

distribution of financial products with private customers fell approximately 15

from euro 675 billion to euro 574 billion6 Though the retail banking sector has

experienced some increase in profits due to cost reduction and reduced loan

failures in 2007 market potential still stagnated in 20097

Since the financial crisis has raised the awareness of the threats of investment

banking many banks have refocused on core business activities in order to

maintain their solvency through increased account deposits Banks need money to

grant loans to private individuals or enterprises provide investment opportunities

finance consumer goods or simply realize baking transactions Yet the recent

financial crisis caused distrust among the banks and loans will not be granted as

1 Plickert (2009) 2 Deutsche Bank (2009) 3 Koumlhler and Lang (2008) 4 Spiegel Online (2007) 5 Welp (2009) 6 Zebrolfesschierenbeckaccosiates (2008) 7 McKinsey amp Company (2007) Zebrolfesschierenbeckaccosiates (2008)

2

easily as before On the consumer side the financial crisis has increased the

demand for secure money investments A survey of 230 highly ranked managers

from private savings and co-operative banks on the effects of the crisis on their

business indicates that banks have concentrated more intensively on business with

private customers both during and after the latest crisis Moreover customer

demand for certificates company shares or funds has fallen significantly while the

demand for standard retail banking products such as call money accounts or

account books has increased substantially8

In spite of its high competitiveness and low profit margins the German retail

banking market is still attractive for foreign banks Foreign MNBs are increasingly

able to penetrate the market for private individuals9 In particular they gain market

share through new products decreasing prices standardized processes and

innovative marketing whereas domestic banks have often relied on continued

customer loyalty10 Although foreign multinational banks in Germany have usually

concentrated on large domestic corporations engaged in international

transactions11 they now enter the market for private and small corporate clients as

well12- a trend that has been supported by the development of internet technology

and other new marketing - channel options

The distinctive characteristics of the German banking market raise several

questions concerning both entry mode and business model considerations of

multinational banks Should a multinational bank engage in cross-border lending or

rather enter the market via foreign direct investment How do the development of

economic political-legal and social-cultural factors in the German market affect a

multinational bank`s entry mode and business model choice

This thesis distinguishes between the non - equity entry modes of cross-border

lending and alliances as well as the equity entry modes of representative offices

branches subsidiaries and JVs both from a Greenfield investment and an

acquisition point of view Each of these organizational entry mode forms has

8 Welp (2009) 9 Reitz (2005) 10 McKinsey amp Company (2007) 11 Hersh and Weller (2002) 12 Koumlhler (2008)

3

distinctive advantages and disadvantages Hence the main focus of this thesis is to

provide a broad understanding of the distinctive market entry and penetration

strategies in light of macro and micro economical developments in Germany

11 Research Objective

This thesis examines entry mode choice decisions and business model

considerations of multinational banks entering the German retail banking sector

The objective is to evaluate the affect of current market developments on their

entry mode decisions

In light of the financial crisis and the banks` rediscovery of the private individual

the German banking sector is currently experiencing a renaissance resulting in

increasing industry rivalry At the same time the processing of bank transactions

and customer services is becoming increasingly independent of the branch

distribution channel and the adoption of new technologies is substantially affecting

the allocation of retail banking services13 The technological evolution is

exemplified by the emergence of web-based direct banks which have been able to

penetrate the retail banking market with low-cost structures innovative ideas and

distinctive service thinking

Eventually the growing importance of the internet and other technological means

as distribution channels on the one hand and the remaining strong demand for

personal consultation on the other hand require a customer-oriented multi-channel

management of the banks14

This paper contrasts the two opposing ends in the field of retail banking

distribution channels It simplifies the entry mode choice between direct banks that

solely operate through the internet and brick amp mortar banks which solely operate

through a branch network Furthermore it differentiates between branch entry via

Greenfield investment and subsidiary entry via acquisition

Two major questions will be addressed

13 Deloitte (2010) 14 Welp (2009)

4

Firstly to what extent do demographic and technical developments favor a direct

bank entry mode over a brick and mortar bank approach in Germany

Secondly what affects the decision in favor of a branch entry mode via Greenfield

investment as compared to a subsidiary entry mode via acquisition in Germany

12 Structure

This thesis is systematically divided into two different complexes - a theoretical

and a practical After a classification of essential banking terms in the section 2

Section 3 then describes relevant market entry theories ndash namely the Transaction

Costs Theory and the Eclectic Theory as well as market entry strategies ndash namely

the offensive and the defensive strategies of expansion

In section 4 the German retail banking market is analyzed within the five forces

framework The goal of this examination is to evaluate market attractiveness and to

identify micro and macroeconomic developments that may shape the market in the

future

Given the theoretical framework of section 3 and the knowledge of industry

structure and trends of section 4 section 5 explores the decision driving factors of

entry mode choice In this section cross-border lending alliances joint ventures

and representations will be discussed Furthermore this section indicates what

affects the decision in favor of a branch entry mode via Greenfield investment as

compared to a subsidiary entry mode via acquisition and to what extent

demographic and technical developments favors a direct bank entry mode over a

brick and mortar bank entry mode in Germany

Section 6 introduces the SWOT analysis as well as the Service Marketing Mix and

applies these concepts to the ING - DiBa case study It illustrates how ING- DiBa

penetrated the German retail banking market with both the implementation of the

direct banking business model and the exploitation of external opportunities

Finally this thesis concludes with a summary of the major findings

5

2 Classification of Banks

21 Bank

This paper refers to banks as defined in the German Banking Act Section 1 GBA

defines financial institutes as enterprises which pursue banking transactions

insofar as the extent of these transactions requires commercial business operations

At least one of the following transactions has to be carried out security

transactions credit transactions payments transactions or other banking business

The enterprise which pursues banking transactions in Germany requires the

permission of the BaFin (Federal Institution for Finance Service Supervision)

according to section 32 GBA

22 Direct Bank

Direct banks are credit institutes which operate without a branch network and

utilize the internet and the telephone as direct communication channels through

which banking transactions are realized and marketing and customer service takes

place Thus direct banks establish cost advantages which they usually transmit in

the form of attractive terms15

23 Brick and Mortar Bank

A brick and mortar (BampM) company is a traditional street-side business that

deals with its customers face to face in an office that the company owns or rents16

A brick and mortar bank serves consumers in a physical facility as distinct from

providing online or telephone services only The term brick and mortar is not a

generally valid classification of a bank but in the jargon of e-commerce it is

frequently employed to distinguish from internet based enterprises In this thesis

the term brick and mortar bank is employed to differentiate between a direct bank

that operates through direct channels and one which operates solely through its

branch network The term brick and mortar is also distinguished from the term

click and mortar which is an expression for a form of multi-channel retailing in

15 Deutsche Bundesbank (2010) 16 Investopedia Dictionary (2010)

6

which both electronic distribution channels (click) and physical premises (mortar)

are utilized17

24 Multinational Bank

Multinational banks are defined as banks that have a physical presence in more

than one country In contrast international banks engage in cross-border operations

but do not establish a physical presence in foreign countries18

25 Retail Bank

There is no generally valid classification of retail banking in theoretical literature

or in practice19 A distinction in retail banking is often made with regard to its

target clientele In this regard some authors define retail banking as the offering of

banking and financial services to individuals and small and medium sized

enterprises20 Other sources define retail banking as the provision of these services

solely to individuals21 This paper employs the following classification of retail

banks `A retail bank is a bank that caters for ordinary individuals and small

business as distinct from large corporations Retail banking operations offer

deposit facilities lend money transfer funds and are prepared to deal in relatively

small amounts`22 In contrast to private and corporate banking retail banking

considers private clients with low to average income as well as small corporate

clients

2

Figure 1 Classification of retail banking clients

(own illustration based on Swoboda 2004)

17 Gabler Wirtschaftslexikon (2010) 18 Hersh and Weller (2002) 19 Muumlller and Joumlhnk (2005) 20 Pond (2007) FinanceWiki (2008) Tremblay and Tremblay (2007) 21 Frei Harker and Hunter (1998) Online Businessdictionarycom (2010) Investoglossarycom (2010) 22 Essvale Corporation Limited (2007)

Retail Banking

Medium and large corporate clients

Wealthy private clients

Small Corporate clients

Private clients

7

3 Market Entry Theories and Strategies

31 Transaction Costs Theory

In the transaction cost theory developed by Ronald Coase and Oliver E

Williamson a comparison of transaction costs determines the optimal form of

organization In TC Theory the entry mode decision is a tradeoff between the

control and the costs of resource commitment Entry modes vary in three major

aspects the cost of resource commitment control as the level of ownership and

environmental risks that may affect the committed resources Hence high-control

modes increase both risk and the potential return23

Williamson differentiates between ex-ante and ex-post transaction costs

Information and searching costs are incurred ex-ante in the process of collecting

market information and identifying suitable partners Negotiation and contract

costs arise ex-ante due to negotiations legal advisory and the determination of

contractual terms Monitoring costs develop ex-post for activities which serve to

control contractual obligations Conflict and enforcement costs arise ex-post due to

the different interpretation of the contract and the costs of enforcing contractual

regulations with sanctions negotiations or through court proceedings Adaption

costs are incurred due to ex-post changes in contractual agreements that become

necessary because of unpredictable developments24

TCE assumes the existence of bounded rationality and opportunism Bounded

rationality describes the limitation in human processing of information and the

planning of possible outcomes Opportunism describes the notion that humans may

act in a self-interested manner by manipulating information and being dishonest

The consequences of these assumptions are incomplete contracts and moral

hazards25 Vice versa opportunism occurs because firms can not write complete

contracts

The size of the transaction costs is determined in each case by the characteristics of

asset specificity uncertainty and frequency Asset specificity arises when the actor

in the market undertakes specific investments in order to fulfill his contractual 23 Chen and Mujtaba (2007) p322 24 Kieser and Ebers (2006) p278 25 Magill and Quenzii (1996) p11

8

obligations It refers to the degree to which long-lasting human or physical assets

are bound in a specific relationship and thus to the extent to which they provide

value in the context of a different situation26 In TCE markets can hardly solve the

problems that high uncertainty creates in combination with bounded rationality and

threats of opportunism Uncertainty includes environmental and behavioral

uncertainty Environmental uncertainty refers to political legal cultural and

economic uncertainties that may affect the success of business transactions

Behavioral uncertainty states that bounded rationality and the threat of opportunism

result in the high costs of monitoring a partner company27 If the similar

transactions are repeated frequently learning effects and economies of scale occur

and will reduce the transaction costs

32 Eclectic Theory

The eclectic theory28 (or OLI paradigm) was developed by John Dunning and is a

framework that merges different economic theories which explain foreign market

entry patterns of multinational corporations29 It states that the internationalization

of MNCs is determined by three sets of independent variables ownership

advantages (or firm- specific advantages) location advantages (or country specific

advantages) and internationalization advantages

The ownership advantage considers the competitive advantages of MNCs arising

from firm-specific characteristics such as size monopoly power economies of

scale management brand name technology and other resource capabilities30

These advantages are usually intangible assets and can be transferred at low costs31

The greater the competitive advantage of the MNC is the more likely it is able to

start or to increase its foreign production32

The location advantages arise from country specific benefits that can be divided

into three categories Firstly a host country may have economic advantages

comprising qualitative and quantitative factors such as production transports costs

26 Dietrich (1994) p18 27 Brouthers and Brouthers (2003) p1183 - 1185 28 Dunning (1980) Dunning (1988) Hill Kwang and Kim (1990) 29 Dunning (2002) 30 Forsbaeck and Oxelheim (2004) 31 Griffin and Pustay (2006) 32 Dunning (2002)

9

communication costs market size or tax incentives Secondly a host country may

offer political advantages in particular governmental policies that may influence

market entry Thirdly a host country may provide social and cultural advantages

including the psychic distance between the foreign and the domestic country as

well as language or cultural aspects that may have an impact on the market entry

decision The higher the attractions of the specific location the more likely it is that

MNCs will exploit their ownership advantage by entering the foreign market33

Because of the existence of transactions costs the internationalization incentive

advantage states that it must be profitable for the MNC to exploit these advantages

itself rather than through local companies (eg licensing)34

In economic literature the OLI paradigm has also been applied to the banking

sector In this regard ownership advantage may include easy access to a vehicle

currency Locational advantages may include country-specific regulations and

entry barriers Internationalization advantages can be information advantages and

access to local deposit bases35

Many empirical studies on the banking market have utilized the eclectic paradigm

as a basic framework For example a study of bank entry into CEE markets

concludes that the ownership advantages of foreign MNBs are strong compared to

banks in emerging markets and especially when the foreign country experiences a

banking crisis36 An application of the OLI paradigm to the Spanish banking

market has shown that bank size and multinational experience of MNBs favor

stronger commitment in the foreign country whereas distance is an entry barrier37

However theoretical literature also states that in service industries clients close to

the MNBs headquarters may be served from this location whereas clients in distant

markets require a physical presence of the MNB in the foreign country which

favors a foreign market entry with increasing distance38

33 Dunning (2002) 34 Hagen (1997) 35 Yannopoulus (1983) 36 Uiboupin and Sorg (2006) 37 Blandoacuten (1998) 38 Blondoacuten (1998) Terpstra and Yu (1988)

10

33 Strategy of Defensive Expansion

A common approach employed to explain the expansion of MNBs involves the

theory of defensive expansion which is also referred to as the acutefollow-the-

customeracute argument

This theory states that MNBs expand abroad in order to provide services for

domestic clients which are often large enterprises that have entered a foreign

market39 The provision of financial services in the foreign country usually requires

a presence at important economic centres Hence to some degree expanding

corporations impose pressure on their domestic banks to follow-up40

The term acutedefensiveacute is derived from the idea that a failure to expand may lead to a

loss of the client not only in the foreign country but also in the domestic one as

the client may associate with a foreign MNB41 Consequently MNBs which pursue

this strategy seek to prevent losses rather then to generate new profits in the foreign

market42 Furthermore the domestic bank has an incomparable competitive

advantage over banks in the foreign country with regard to the knowledge of

customer needs the respective risk of credit default as well as an interest in cross-

selling products such as financial advisory43

Due to earlier business relationships with the client the domestic bank has reduced

costs for examining the financial capacities of the respective enterprise and thus

can offer cheaper services44 Most foreign entry evidence supports the defensive

expansion theory45

A study on this theory with respect to retail banking has revealed that MNBs

sometimes expand abroad in order to provide banking services to specific

communities46

39 Trend im retail-banking koumlhler 40 Henneberger and Graf (2000) 41 Mullineux and Murinde (2003) 42 Naaborg (2007) 43 Knoop (2006) 44 Bhattacharya (1994) 45 Bhattacharya (1994) Naaborg (2007) 46 Tschoegl (1987)

11

34 Strategy of Offensive Expansion

MNBs that offensively expand abroad primarily seek to increase their customer

base both in the home and in the foreign country Firstly the establishment of

foreign branches and subsidiaries enables the MNB to expand their services to

domestic residents who benefit from the international orientation of the bank

These may include customers that have business partners in the foreign country

Secondly MNBs may target new customers in the foreign country in particular

MNEs or foreign subsidiaries of domestic enterprises As the MNB must in both

cases entice customers away from other banks the MNB has to offer attractive and

competitive conditions for their financial services47

47 Buumlschgen (1998) p604

12

4 Industry Analysis German Retail Banking Sector

41 Porter`s Five Forces

In the school of Industrial Economics the five-forces model has established itself

as a core element of industry analysis Porter`s analysis framework is built on the

following five market forces that shape the strategy of competitors threat of new

entrants threat of substitute products or services bargaining power of buyers and

suppliers as well as rivalry among existing competitors

Porterrsquos concept is based on the knowledge that the strategy of an enterprise must

orient itself to its market environment whereby the competitive strategy arises

from a differentiated understanding of the market structure and the knowledge of

how it changes The effects of these forces determine the intensity of the

competition in a market and with it its profitability and attractiveness Therefore

the aim of the enterprise strategy should be reflected in the search for possibilities

for the reduction or use of these competitive forces relative to its own enterprise In

this regard Porter`s model is conducive to the analysis of the driving forces

working in the respective industry

Figure 2 Michael E Porter`s five forces model (Own illustration based on Porter 1979)

Industry Rivalry

Threat of New

Entrants

Bargaining Power of

Buyers

Threat of Substitute Products

and Services

Bargaining Power of Suppliers

13

Porter`s framework is a useful and frequently utilized analytical tool to describe the

foundations of industry competition

A high degree of rivalry among the existing enterprises leads to high competitive

pressure and can lower profit margins and the profitability of individual

enterprises In situations in which a large number of enterprises target similar

market segments with comparable strategies in which the market grows slowly

price is the most important differentiation factor and high exit barriers exist a

negative impact on the industryrsquos profitability is effected48

The threat of new entrants can be determined by the entry barriers of a market The

competitive pressure on existing enterprises increases with low entry barriers In

such a situation important elements of the market (eg shares of the market price

level) can change due to the entry of new market participants49

The bargaining power of buyers determines to what extent customers can influence

enterprises by the amount of consumption and the pressure on margins Important

indexes of a high degree of buyer power include high fixed costs in the industry

existence of supplements of the product or service high degree of customer

concentration customers` knowledge of production costs possibility of a reverse

integration of customers high growth rates of the market and a strong

individualization of customer demand50

The bargaining power of suppliers affects industry profitability if for example a

concentrated supplier group dominates over existing enterprises in the market

which are not important buyers for the suppliers Then the industry faces high

margin pressure by the suppliers

A threat of substitute products and services exists in particular if cheaper or higher-

quality products and services are able to reduce existing sales volumes of a market

or an enterprise51 The future sales potential of existing enterprises becomes limited

and industry competition increases

48 Porter (1985) 49 Porter (1979) Recklies (2001) 50 Recklies (2001) 51 Recklies (2001)

14

Critics of this model state that it neglects the impact of complements as a sixth

force of the industry since they may facilitate or hinder the commercialization of

certain goods However Porter argues that complements are not a force itself but

they affect profitability in the way that they influence the five forces and that `the

strategist must trace the positive or negative influence of complements on all five

forces to ascertain their impact on profitability`52

One limitation of this model is based on studies which indicate that company-

specific factors may have a more important impact on profit than industry forces53

Furthermore the model suggests relatively static and stable market structure which

makes it difficult to assess contemporary dynamic markets54

The model does not assess the impact of the parent company on its subsidiary

which is especially important in the banking sector in which parent companies

often have a strong impact on the performance of their subsidiary or branch The

parenting advantage includes the stand-alone influence through monitoring and

influence on management decisions or capital expenses Furthermore parents

create value by enhancing synergies within the group offering corporate functions

or managing portfolios55

42 Rivalry among existing competitors

In this section the intensity of competitive rivalry among existing competitors in

the German retail banking sector is discussed In this regard an analysis of industry

structure industry growth and exit barriers will be conducted

Industry structure The German banking market is characterized by a three-pillar

system which is reflected by the strict distinction between public-law banks

cooperative banks and private banks56 Each pursues different goals and is subject

to different regulations Private commercial banks pursue the goal of profit

maximization whereas saving banks serve the public contract of offering secure

52 Porter (1997)p11 53 Zack (1999) 54 Recklies (2001) 55 Goold Cambpell and Alexander (1994) 56 Gramlich (2005)

saving possibilities and loans C

interest of their members

banking market is structured as follow

Figure 3(own illustration based on Sch

Public-law banks including saving banks and state banks

total balance sheet volume of banks in Germany

do not participate in retail banking The cooperative bank sector amounts to 11

the total including cooperative banks

cooperative central banks

commercial banks including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

31 of total balance sheet volume

European Research (ZWE) 43 of experts state that the three

important or very important and

for the low number of cross

In order to describe industry rivalry among maj

retail sector the following table illustrates the number of customers per bank in

Germany

57 Engerer (2006) 58 Koumlhler (2008b)

banks 24

Private commercial banks 31

15

possibilities and loans Cooperative banks primarily serve the economic

interest of their members57 In terms of total balance sheet volume the German

banking market is structured as follows

Figure 3 Structure of the German Banking Sector(own illustration based on Schrooten 2009)

law banks including saving banks and state banks amount to 33 of the

total balance sheet volume of banks in Germany However state banks

do not participate in retail banking The cooperative bank sector amounts to 11

including cooperative banks which participate in retail ban

cooperative central banks which primarily serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

alance sheet volume According to a recent survey of the Center for

European Research (ZWE) 43 of experts state that the three-pillar system is

important or very important and 33 state that it is the critical factor responsible

cross-border mergers and acquisitions in Germany

In order to describe industry rivalry among major banks that participate in the

the following table illustrates the number of customers per bank in

Savings banks 13

State banks 20

Cooperative central banks

3Credit cooperative banks 8

Other banks 24

serve the economic

sheet volume the German

Structure of the German Banking Sector

amount to 33 of the

However state banks generally

do not participate in retail banking The cooperative bank sector amounts to 11 of

participate in retail banking and

serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks amount to

According to a recent survey of the Center for

pillar system is

33 state that it is the critical factor responsible

border mergers and acquisitions in Germany58

or banks that participate in the

the following table illustrates the number of customers per bank in

State banks 20

Cooperative central banks

16

Figure 4 Customers of German Banks at the end of 2007 in millions (own illustration based on Deutsche Bank 2008)

With approximately 50 million customers savings banks are the market leader in

the German retail banking sector Although state liability assumption for savings

banks was abolished in 2005 because the EU saw in it an unacceptable subsidy to

the disadvantage of private banks customers still associate the name `Sparkasse`

with state guarantees The specific characteristic of a saving bank is based on its

public contract in that it has to accept customers with poor credit-worthiness that

profits should be used to enhance public wealth and that the middle class should be

supplied with loans59

With approximately 30 million customers cooperative banks are the second major

player in the German retail banking sector Nearly half of these customers are

members of the cooperative banks60 In contrast to the profit maximization goal of

private commercial banks their aim is to fund their members and secure their

economic independence Although cooperative banks are economically and legally

independent in the different regions they appear uniformly as a group under the

brand of ldquoVolks- und Raiffeisenbankenrdquo With regard to growth in customer base

cooperative banks benefit from the advantage of having the regional flexibility that

59 Kruck (2008) 60 Online Raiffeisen Bank Homepage

31

4

61

118

242

30

50

0 10 20 30 40 50 60

Citibank

Hypovereinsbank

ING DiBa

Commerzbank and Dresdner Bank

Postbank and Deutsche Bank

Credit Unions (Volksbanken)

Savings Banks (Sparkassen)

17

allows for topical advertisement as well as a centralized management focus on

improving reputation61

The third group comprises the major private commercial banks including Deutsche

Bank Postbank Commerzbank and Hypovereinsbank Deutsche Bank is a leading

multinational investment bank but with relatively low market share in the retail

banking market Deutsche Bank (97 million clients) is acquiring Postbank (145

million clients) with its broad branch network in a three-step process Together

they have 242 million clients However Heino Ruland from the analyst company

Frankfurt Finanz Partner argues that Deutsche Bank might not be able to capitalize

on the financially weaker Postbank clients as Deutsche Bank is specialized in

corporate clients62 With regard to rivalry intensity and market profitability Rainer

Neske supervisory board member and head of private amp business clients of

Deutsche Bank emphasizes that the German retail banking market is too

fragmented to be highly profitable and that Deutsche Bank does not seek to

compete on the price level but defines itself through performance quality and

consultancy63

Commerzbank is the second largest private commercial bank in Germany After the

acquisition of Dresdner Bank in 2009 Commerzbank now serves more than 12

million clients (of these 11 million private and one million corporate clients) and

pursues the goal of becoming the market leader in Germany64

UniCredit Bank AG with the brand name Hypovereinsbank (HVB) is a subsidiary

of UniCredirSpA and is the third largest private commercial bank in Germany

HVB serves approximately four million clients predominantly in north Germany

and in Bavaria As its retail banking segment could only report marginal profits in

2009 speculation about a sale or acquisition in this segment has come up As the

Swedish SEB (Skandinaviska Enskilda Bank) is considering selling its German

retail segment with 174 branches and one million clients experts now regard HVB

as a major buying candidate65

61 Schwarzbauer (2009) 62 Kreiler (2008) 63 Deutsche Bank (2009) 64 Kreiler (2008) 65 Houmlpner and Nagl (2010)

18

ING DiBa AG is a subsidiary of the Dutch ING Group and serves over 6 million

clients In contrast to savings cooperative and the major private commercial

banks ING DiBa is specialized in direct banking which distributes services via

telephone the internet or post instead of through branches In Germany ING

DiBa is the leader in direct banking but there are many other direct banks such

as Comdirect (a subsidiary of Commerzbank) Volkswagen Bank or DAB Bank

(a subsidiary of HVB) Competition takes place not only among direct banks but

also between direct and branch banks For instance many saving banks have

blocked the opportunity for customers of direct banks to withdraw cash from their

automated teller machines As savings banks can only charge Euro 174 for

withdrawals via visa cards they fear that direct banks can gain market share by

offering attractive account options with a convenient wide-area ATM provision66

Targobank (former Citibank Deutschland) was acquired by the French

cooperative bank Creacutedit Mutel and now serves more than 34 million clients in

Germany in 2010 The bank is specialized in private retail customers with

branches and direct banking67

In conclusion the degree of concentration in the German retail banking market is

very low which reduces the overall profitability of this sector for two main

reasons Banks earn higher profits in concentrated markets as they obtain either

monopoly rents (structure-conduct-performance paradigm) or due to high market

shares that are gained by more efficient and profitable banks (efficient structure

hypothesis)68 As retail banking services are largely standardized product

differentiation is low and price differentiation is often the only option As public-

law banks serve other interests than profit maximization existing private banks

and MNBs that want to enter this market have a competitive disadvantage The

low switching costs of clients intensifies competition on the price level and thus

reduces the profitability of the market However brand identification and

customer relationships are also important which decreases the willingness of

clients to switch solely on the basis of price comparison In summary market

structure indicates a very high degree of rivalry among existing competitors

66 Online Financial Times Deutschland (2010) 67 Targobank (2010) 68 Havrylchyk and Jurzyk (2006) p15

19

Industry growth In this section industry growth will be examined in a dynamic

analysis of three relevant market growth indicators the future long-run

development of the German population the historical development of the number

of banks and branches in Germany and the historical development of market-

share allocation in the context of major retail banking activities

In the long-run market growth depends on the future numerical development of

the market`s customers - the German population As the growth of population

through birth and immigration is smaller than its decrease by virtue of the mortality

rate and emigration the Federal Statistical Office in Germany estimates a sharp

decline of the German population

Figure 5 Estimated Development of German Population (in millions)

(Federal Statistical Office 2009)

The Federal Statistical Office predicts that the trend of decline in population since

2003 will continue and intensify Whereas approximately 82 million people lived

in Germany in 2008 only between 65 million (average lower limit of the

population with 100000 immigrants yearly) and 70 million people (average

upper limit of the population with 200000 immigrants yearly) will reside in

Germany in 2060 Furthermore the decreasing number of births and the ageing of

the current strongly represented middle age group will lead to substantial changes

in the age structure of the population From 2008 to 2060 the proportion of people

from 65 to 80 years will increase 15 to 20 and the proportion of people over

80 years of age will increase from 5 to 14 of the population69 The

69 Federal Statistical Office (2009)

Average lower limit

Average upper limit

20

implications of the aging population for banks will be discussed in the comparison

between direct banks and BampM banks in section 66 of this thesis

The second indicator of industry growth deals with the number of banks and bank

branches in the German market The overall number of banks in Germany

decreased from 3785 in 1995 to 2300 in 2006 As retail banking usually depends

on the number branches maintained their development in Germany will be

examined

Figure 6 Development of Total Bank Branches in Germany (own illustration based on Koumlhler2008a)

Savings banks and cooperative banks have reduced the number of branches

significantly Public-sector banks (savings banks state banks etc) with 18757

branches and cooperative banks with 16028 branches in 1998 reduced the

number of branches to 14252 and 12303 respectively in 2006 Moreover the

number of branches of major commercial banks decreased from 19055 in 1998 to

8879 in 2006

The main cause for the decrease of branches is the high fixed costs which can not

be recouped from low-revenue standard products that can also be distributed

through alternative low-cost channels such as the internet70

70 Koumlhler and Land (2008)

67930 6666363186

59929 58546 5693653931

5086847244 45467 44100

40332

0

10000

20000

30000

40000

50000

60000

70000

80000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

21

As a third indicator of industry growth this paper reflects on the allocation of

market share within the retail banking sector in order to indentify trends that may

affect overall market growth This paper will reflect on market share in two major

retail banking segments - savings deposits and loans The German Central Bank

classifies the banking market in terms of savings banks cooperative banks direct

banks and credit banks The latter include universal banks which are private

commercial banks branches of foreign banks regional banks and other private

banks

This section reflects the development of market share regarding short- medium-

and long-term saving accounts and examines the allocation of loans to corporate

clients consumers (consumer loans) private households and self-employed

persons

In the period from 1998 to 2006 the market for medium-term saving deposits with

a cancellation period under three months has been dominated by saving banks (53

market share in 2006) and cooperative banks (29 market share in 2006) In the

same period the market share for long-term saving deposits with a cancellation

period above three months has also continuously been dominated by savings banks

(65 market share in 2006) and cooperative banks (24 market share in 2006)

However with regard to deposits that mature daily direct banks were able to

increase market share from approximately 15 in 1998 to over 15 in 2006

Figure 7 Market share development of saving accounts that mature daily (own illustration based on Deutsche Bundesbank 2007)

000

500

1000

1500

2000

2500

3000

3500

4000

4500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Banks

Cooperative Banks

Savings Banks

Credit Banks

22

From 1998 to 2006 market share for loans for corporate clients has been

continuously dominated by credit banks (53 market share in 2006) and savings

banks (34 market share in 2006) However this data also comprises loans for

medium and large corporations which are not part of the retail banking market

Loans for private households and self-employed persons have predominately been

granted by savings banks (39 market share in 2006) credit banks (30 market

share in 2006) and cooperative banks (25 market share in 2006) though direct

banks were able to gain some market share from 0 in 1998 up to 5 in 2006

Even more significantly direct banks were able to gain over 16 market share in

the segment of consumer loans

Figure 8 Market share development of consumer loans (own illustration based on Deutsche Bundesbank 2007)

Hence the most significant growth indicator of the retail banking market results

from the emergence of direct banks which were able to gain substantial market

share in consumper loans and deposits that mature daily

In conclusion the industry growth analysis indentifies the following growth

indicators Firstly a sharp decrease in the German population in the following

decades will reduce growth and increase industry rivalry Moreover the

demographic change increases the proportion of old people in the population

Secondly the number of branches in Germany is decreasing due to high fixed

costs of branches In order to be profitable in retail banking the existing branches

must serve a large quantity of customers which leads to strong competition

relative to market share Thirdly the development of market share allocation

000

1000

2000

3000

4000

5000

6000

7000

2002 2003 2004 2005 2006

Savings Banks

Cooperative Banks

Direct Banks

Credit Banks

23

indicates that only direct banks have experienced significant growth from 1995 to

2006

Exit barriers From a perspective of Transaction Costs Economics one can argue

that exit barriers in branch banking are high for market participants as branches

and staff are highly specific assets that lose value when used in another situation

To a large extent these assets are locked into the context of retail banking

Moreover public-law banks usually have to serve the population regardless of

whether they are profitable or not In a situation in which a bank continuously

experiences losses staff and branches may be considered as sunk costs and thus

economically `irrationalacute exit barriers However theories suggest that staff and

branches are practically valid exit barriers and cause MNCs to stay in a market71

The high degree of exit barriers intensifies the strong rivalry among existing

competitors

43 Threat of New Entrants

New entrants usually seek to gain market share while applying pressure on prices

and costs and thus increasing the investments necessary to compete An expert

survey conducted by the ZEW emphasizes the importance of entry threat to the

German retail-banking market 6666 of market experts state that new

competitors (eg foreign banks) have an important or a very important impact on

industry rivalry72

In this section the threat of new entrants to existing market participants in the

German retail banking sector is discussed In this regard this section evaluates

legal entry barriers capital requirements the necessity of large scale operations

customer switching costs and incumbency advantages of existing domestic banks

Legal entry barriers are determined by governmental regulations in the German

Banking Act (GBA) and are supervised by the Federal Supervisory Authority73

According to section 32 para 1 (1) GBA companies that intend to pursue

commercial banking transactions or financial services in Germany require written

71 Hill Hwang and Kim (1990) 72 Koumlhler and Lang (2008) 73 Bundesanstalt fuumlr Finanzdienstleistungsaufsicht (2005)

24

permission from the Federal Financial Supervisory Authority ( ldquoBundesanstalt fuumlr

Finanzdienstleistungaufsichtrdquo) The execution of banking transactions or financial

services also exists when the operator has its headquarters or primary residence

abroad but repeatedly targets companies or individuals who have their primary

residence in Germany In order to obtain the permit several requirements are

examined (eg business plan qualified management etc)

Companies from third countries which intend to conduct banking transactions and

provide financial services in Germany must establish a subsidiary (section 32 para

1 in connection with ection 33 para 1 (6) GBA) or a branch (section 32 para 1 in

connection with section 53 GBA) in Germany Companies from third countries can

apply for an exemption according to section 2 para 4 GBA if the company is

supervised utilizing international accounting standards in the home country and the

responsible authority works together with the BaFin According to section 53b

GBA companies of EEA states are allowed to establish branches (section 53b para

2) but are also free to conduct cross-border financial services without a domestic

presence (section 53b para 2a) Section 32 para 1 GBA does not apply to business

that is motivated by the initiative of the domestic individual or enterprise (so called

passive service freedom)

Representations are limited to their representative function and are not allowed to

conduct or initiate any banking business

Capital requirements are low for cross-border lending and and relatively low for

representations With high equity modes such as branches and even more so with

subsidiaries capital requirements are relatively high as capital is required for

building a broad network of facilities and offering credit to customers Capital

requirements for direct banks are relatively low compared with those of BampM

banks

The necessity of large scale operation is related to the competitive advantage of

economies of scale A company that serves the market in the context of larger

quantities benefits from lower cost per unit In retail banking profit is gained by

having a large number of clients It is expensive to build up these numbers and to

establish a distribution network to serve them This necessity relates directly to the

strategy of the bank An acquisition offers a shortcut to these facilities although the

25

costs of integration can be high as well74 A MNB may also decide to target only a

certain geographical area with certain clients and therefore do not have to enter on

a very large scale

Customer switching costs are different for each individual In general customers

can easily change their banks and open a deposit account or apply for a loan at

another bank However they have to compare the different terms for usually small

transactions to evaluate the convenience of having a bank nearby and then to

decide to terminate the relationships with their current bank75

Finally the incumbency advantages of existing banks are important entry barriers

In particular they include established brand reputation possession of the most

favorable geographical locations and market knowledge Moreover established

banks may already have exclusive contracts with SMEs76

To conclude legal entry barriers are low and particularly low for banks from the

EEA Capital requirements for entering the market are high yet as far as equity

entry modes are concerned direct banks require relatively low capital as they

distribute their services through low-cost channels Banks need to attract many

customers to be profitable but banks strategy dictates whether or not to entrance

should occur on a large scale Moreover the incumbency advantages of existing

banks constitute important entry barriers

44 Threat of Substitute Products or Services

A substitute in retail banking is a service that offers an attractive trade-off to a bank

service or product As individuals and small firms do not regularly report financial

information as do large enterprises they rely primarily on bank lending However

there are additional forms of financing in the private equity or dept market77

Many non- and near- banks provide substitute products and services Near-banks or

quasi-banks are suppliers of financial services but are not classified as credit

institutes according to section 1 GBA Near-banks such as insurance companies or

credit card organizations however do provide substitute products or services Non-

74 Hughes and MacDonald (2009) 75 Adams (2002) 76 Adams (2002) 77 Xiaoqin and Terada-Hagiwara (2003)

26

banks such as department store chains catalog companies or car producers also

provide substitute services78 For instance instead of taking out a loan in order to

pay for a product individuals or small enterprises may decide to take on a leasing

contract for a certain asset or small enterprises can obtain a trade credit as well

Individuals may decide on buying products from insurance companies instead of

putting money into a bank account

Another substitute for both direct and BampM banks is the person-to-person (p2p)

lending business a new form of borrowing and lending money that takes place in a

web-based market place In this online platform borrowers are connected to

lenders through an auction-like process in which a lender who bids to provide a

loan for the lowest interest rate will be awarded the loan contract with the

borrower A p2p company mediates between private or company borrowers and

lenders and also executes transactions between the parties similar to the role which

e-bay plays in the trade of commercial goods79 The p2p lending business does not

involve traditional banks and thus can offer superior interest rates to borrowers and

higher returns for lenders

45 Bargaining Power of Suppliers

When a supplier group is more concentrated than the industry does not primarily

depend on the industry and when the industry faces high switching costs the

supplier group has strong bargaining power and can reduce the profit potential of

an industry In the retail banking market the most relevant suppliers include human

resources suppliers of capital resources and suppliers of information and

communication technology (ICT)80 Highly talented or experienced specialists are

strongly canvassed and have strong bargaining power with respect to their salary

and working conditions However in the aftermath of the financial crisis many

banks are planning a reduction of staff According to a study of Ernst amp Young

every fifth bank intends to decrease staff and only every 10th bank is planning an

increase81 Given the current situation of the employment market the bargaining

power of employees is relatively low Suppliers of highly specialized banking ICT

78 Gabler Wirtschaftslexikon (2010) 79 Deloitte (2009) p 12 80 Buumlschgen and Boumlrner (2003) 81 Ernst amp Young (2009)

27

solutions have strong bargaining power as switching costs for these systems are

very high Moreover the higher yield requirements of shareholders can be

interpreted as supplier power

46 Bargaining Power of Buyers

In retail banking there are many buyers with relatively low transaction volumes

which weakens their bargaining power However retail banking services are

standardized and buyers can easily find similar services Switching costs have

usually been relatively high for these low volume transactions but in the age of the

internet the market is very transparent and buyers can screen different offerings

more easily This does not necessarily imply that the cheapest banking service will

be chosen automatically as customers also seek a trustworthy brand especially in

times of financial crisis Moreover there are other factors that affect the switching

cost of the individual such as the location of the branch Yet there is a tendency

towards the increasing bargaining power of buyers

This is also substantiated by the ZEW survey 7984 of market experts state that

decreasing customer loyalty and increasing price sensibility are important or very

important factors with respect to the intensity of competition in the German retail

banking sector A comparison of former and modern retail customers also indicates

that the bargaining power of retail banking service users has increased

Former Retail Customer Modern Retail Customer

Passive information seeking

behavior

Active information seeking behavior

Hardy or little informed Good to very good know-how

High customer loyality Increasing willingness to switch

Fixation on the branch Expects multi-channel banking at all times

and places

Little market transparency High price transparency

Relatively undemanding Demanding

Figure 9 Comparison of former and modern retail customers (own illustration based on Swoboda 2004)

28

5 Foreign Bank Entry Strategies in Germany

This section illustrates mode choices for foreign bank entry in Germany Based on

the hierarchical model of market entry modes82 the foreign bank has the choice of

equity and non ndash equity modes of entry An advantage of the hierarchical model is

that it allows comparing between entry modes on different levels The main

difference between equity and non ndash equity modes is the degree of resource

commitment in the foreign country As classified at the beginning of this thesis

non-equity entry refers to international banking and equity entry refers to

multinational banking

The research question of this thesis considers multinational bank entry modes

International banking however is often a first step towards multinational banking

Hence this thesis will also discuss cross-border lending and alliances as non ndash

equity entry modes The following figure illustrates a comprehensive view of

market entry modes for banks

Figure 10 A hierarchical model of entry mode choices for banks (own illustration based on Pan and Tse 2000)

82 Pan and Tse (2000)

Entry Mode Choices

Non - Equity Modes

Export

Cross Border Lending

Contractual Agreements

Alliances

Equity Modes

Equity Joint Ventures

Greenfield Investment

Branch

Subsidiary

Representation

Acquisition

Subsidiary

Branch

29

The hierarchical model illustrates the various entry mode choices for entering the

German retail banking market The creation of a common European financial

market in which banks can integrate freely is a major goal of the European Union83

The previous section of this paper indicates that entry barriers are relatively low

and that the German market is highly competitive Hence the choice of a proper

entry mode which is appropriate to the capabilities and the strategy of the bank is

even more significant Therefore the following section will reflect on the strategic

concept governing the choice of entry modes as well as the proliferation of these

entry modes in the German retail banking market

An international bank that is not interested in investing equity in the foreign

market can enter by means of cross-border lending or by forming a non-equity

alliance These non-equity entry modes can help the bank to access niche markets

or to exploit locational advantages when the bank is located near the German

border

However a retail bank defined in the beginning of this paper as a bank that

`caters for ordinary individuals and small businessacute and that seeks to enter the

German market in order to gain significant revenue from deposits and loan

business might have to consider a physical presence in the foreign country

The analysis considers entry modes that are perceived as international banking

cross-border lending and non-equity strategic alliances Furthermore the equity

modes JVs and representations will be discussed

Subsequently this section compares the market entry of a branch through

Greenfield investment with the market entry of a subsidiary by virtue of

acquisition as these modes of entry are the most common in the German retail

banking market

Finally the following question will be addressed to what extent do demographic

and technical trends favor a direct bank entry mode over a brick and mortar bank

approach in Germany

83 Fidrmuc and Hainz (2008)

30

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks (own illustration)

51 Non ndash equity modes Export ndash Cross-Border Lending

Cross-border lending is equivalent to the export entry mode and is a simple non-

equity strategy to enter a foreign market A bank which participates in cross-

border lending must assess the creditworthiness of the individual borrower as well

as the country risk which involves the possibility that these loans will be impaired

by economic or political proceedings in the foreign country84 The country risk in

Germany is rather low as it is perceived to have a solid political and economic

situation (Country Rating A2) with a stable and a very efficient business

environment (Country Rating A1)85 As a bank will only have limited access to soft

information about the creditworthiness of the borrower the availability of loans

usually decreases and the interest on loans usually increases with distance86 Soft

information for private loans includes the previous experience with the account

management of the credit user environmental facts and a judgment relative to his

employment contract87 For corporate loans soft facts may include the market

environment corporate structure management a business plan as well as

84 Hughes and McDonald (2003) 85 Online wwwtrade-safelycom (2009) 86 Agrawal and Hauswald (2007) 87 Dizil (2009)

Entry Mode Choices of MNBs

Greenfield Investment

Branch

Brick and Mortar Bank Direct Bank

Acquisition

Subsidiary

Brick and Mortar Bank Direct Bank

V

VI

Table of contents

List of Figures VIII

List of Abbreviations IX

1 Introduction 1

11 Research Objective 2

12 Structure 2

2 Classification of Banks 5

21 Bank 5

22 Direct Bank 5

23 Brick and Mortar Bank 6

24 Multinational Bank 6

25 Retail Bank 6

3 Market Entry Theories and Strategies 7

31 Transaction Costs Theory 7

32 Eclectic Theory 8

33 Strategy of Defensive Expansion 10

34 Strategy of Offensive Expansion 11

4 Structure Analysis German Retail Banking Market 12

41 Porter`s Five Forces 12

42 Rivalry Among Existing Competitors 14

43 Threats of New Entrants 23

44 Threats of Substitutes 25

45 Bargaining Power of Suppliers 26

46 Bargaining Power of Buyers 27

5 Foreign Bank Entry Strategies in Germany 28

51 Cross-border lending 30

52 Alliances 31

VII

53 Joint Ventures 32

54 Representations 33

55 Entry Mode Choice Greenfield-Branch vs Acquisition-Subsidiary 34

56 Business Model Choice Direct Bank vs Brick and Mortar Bank 38

561 Demographical Trends 40

562 Technological Trends 42

6 Case Study ING DiBa 45

61 Corporate Profile ING Group 45

62 Market Entry and Market Penetration 45

63 SWOT Analysis 46

64 ING DiBa SWOT Analysis 48

641 Strengths 48

642 Weaknesses 48

643 Opportunities 49

644 Threats 49

65 The Service Marketing Mix 50

66 ING DiBa Marketing Mix (7Ps) 52

67 Summary 55

7 Conclusion 56

Literature

Appendix

VIII

List of Figures

Figure 1 Classification of retail banking clients 6

Figure 2 Michael E Porter`s Five Forces model 12

Figure 3 Structure of the German banking sector 15

Figure 4 Customers of German banks at the end of 2007 (in millions) 16

Figure 5 Estimated development of the German population (in millions) 19

Figure 6 Development of total bank branches in Germany 20

Figure 7 Market share development of accounts that mature daily 21

Figure 8 Market share development of consumer loans 22

Figure 9 Comparison of former and modern retail banking customers 27

Figure 10 A hierarchical model of entry mode choices for banks 28

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks 30

Figure 12 Development of foreign MNBs branches in Germany 35

Figure 13 Development of foreign MNBs subsidiaries in Germany 37

Figure 14 SWOT analysis 47

Figure 15 Service Marketing Mix 51

IX

List of abbreviations

ATM Automated Teller Machine

BampM Brick and Mortar

CEE Central and Easter European

EEA European Economic Area

FDI Foreign Direct Investment

GBA German Banking Act

ICT Information and Communication Technology

JV Joint Venture

MNB Multinational Bank

MNE Multinational Enterprise

RDC Remote Deposit Capture

SMEs Small and Medium Sized Enterprises

TCE Transaction Costs Economics

WOS Wholly Owned Subsidiary

ZEW Centre for European Economic Research

1 Introduction

In the aftermath of the recent financial crisis1 and in times in which banks

rediscover the private individual ndash also described as the renaissance of retail

banking2 - significant attention is now being paid to the market entries of foreign

multinational banks3

The German retail banking market is highly competitive Private cooperative and

state-controlled savings banks compete intensely for market share with hardly any

cooperative activities among the groups As savings banks are owned by German

states towns or local authorities they are protected by law from takeovers by

institutes from the other banking sectors4 Due to the high fragmentation of the

German market hardly any bank has dominant market power The five largest

banks have a total market share of only 20 percent and new competitors enter the

market and attract customers with aggressive price differentiation offers5 The

strong competition among private banks savings banks and co-operative banks

results in low profit margins by international comparison The profit potential in

German private-customer business has fallen for many years From 2000 to 2006

total income from the financial service providers in Germany measured by the

distribution of financial products with private customers fell approximately 15

from euro 675 billion to euro 574 billion6 Though the retail banking sector has

experienced some increase in profits due to cost reduction and reduced loan

failures in 2007 market potential still stagnated in 20097

Since the financial crisis has raised the awareness of the threats of investment

banking many banks have refocused on core business activities in order to

maintain their solvency through increased account deposits Banks need money to

grant loans to private individuals or enterprises provide investment opportunities

finance consumer goods or simply realize baking transactions Yet the recent

financial crisis caused distrust among the banks and loans will not be granted as

1 Plickert (2009) 2 Deutsche Bank (2009) 3 Koumlhler and Lang (2008) 4 Spiegel Online (2007) 5 Welp (2009) 6 Zebrolfesschierenbeckaccosiates (2008) 7 McKinsey amp Company (2007) Zebrolfesschierenbeckaccosiates (2008)

2

easily as before On the consumer side the financial crisis has increased the

demand for secure money investments A survey of 230 highly ranked managers

from private savings and co-operative banks on the effects of the crisis on their

business indicates that banks have concentrated more intensively on business with

private customers both during and after the latest crisis Moreover customer

demand for certificates company shares or funds has fallen significantly while the

demand for standard retail banking products such as call money accounts or

account books has increased substantially8

In spite of its high competitiveness and low profit margins the German retail

banking market is still attractive for foreign banks Foreign MNBs are increasingly

able to penetrate the market for private individuals9 In particular they gain market

share through new products decreasing prices standardized processes and

innovative marketing whereas domestic banks have often relied on continued

customer loyalty10 Although foreign multinational banks in Germany have usually

concentrated on large domestic corporations engaged in international

transactions11 they now enter the market for private and small corporate clients as

well12- a trend that has been supported by the development of internet technology

and other new marketing - channel options

The distinctive characteristics of the German banking market raise several

questions concerning both entry mode and business model considerations of

multinational banks Should a multinational bank engage in cross-border lending or

rather enter the market via foreign direct investment How do the development of

economic political-legal and social-cultural factors in the German market affect a

multinational bank`s entry mode and business model choice

This thesis distinguishes between the non - equity entry modes of cross-border

lending and alliances as well as the equity entry modes of representative offices

branches subsidiaries and JVs both from a Greenfield investment and an

acquisition point of view Each of these organizational entry mode forms has

8 Welp (2009) 9 Reitz (2005) 10 McKinsey amp Company (2007) 11 Hersh and Weller (2002) 12 Koumlhler (2008)

3

distinctive advantages and disadvantages Hence the main focus of this thesis is to

provide a broad understanding of the distinctive market entry and penetration

strategies in light of macro and micro economical developments in Germany

11 Research Objective

This thesis examines entry mode choice decisions and business model

considerations of multinational banks entering the German retail banking sector

The objective is to evaluate the affect of current market developments on their

entry mode decisions

In light of the financial crisis and the banks` rediscovery of the private individual

the German banking sector is currently experiencing a renaissance resulting in

increasing industry rivalry At the same time the processing of bank transactions

and customer services is becoming increasingly independent of the branch

distribution channel and the adoption of new technologies is substantially affecting

the allocation of retail banking services13 The technological evolution is

exemplified by the emergence of web-based direct banks which have been able to

penetrate the retail banking market with low-cost structures innovative ideas and

distinctive service thinking

Eventually the growing importance of the internet and other technological means

as distribution channels on the one hand and the remaining strong demand for

personal consultation on the other hand require a customer-oriented multi-channel

management of the banks14

This paper contrasts the two opposing ends in the field of retail banking

distribution channels It simplifies the entry mode choice between direct banks that

solely operate through the internet and brick amp mortar banks which solely operate

through a branch network Furthermore it differentiates between branch entry via

Greenfield investment and subsidiary entry via acquisition

Two major questions will be addressed

13 Deloitte (2010) 14 Welp (2009)

4

Firstly to what extent do demographic and technical developments favor a direct

bank entry mode over a brick and mortar bank approach in Germany

Secondly what affects the decision in favor of a branch entry mode via Greenfield

investment as compared to a subsidiary entry mode via acquisition in Germany

12 Structure

This thesis is systematically divided into two different complexes - a theoretical

and a practical After a classification of essential banking terms in the section 2

Section 3 then describes relevant market entry theories ndash namely the Transaction

Costs Theory and the Eclectic Theory as well as market entry strategies ndash namely

the offensive and the defensive strategies of expansion

In section 4 the German retail banking market is analyzed within the five forces

framework The goal of this examination is to evaluate market attractiveness and to

identify micro and macroeconomic developments that may shape the market in the

future

Given the theoretical framework of section 3 and the knowledge of industry

structure and trends of section 4 section 5 explores the decision driving factors of

entry mode choice In this section cross-border lending alliances joint ventures

and representations will be discussed Furthermore this section indicates what

affects the decision in favor of a branch entry mode via Greenfield investment as

compared to a subsidiary entry mode via acquisition and to what extent

demographic and technical developments favors a direct bank entry mode over a

brick and mortar bank entry mode in Germany

Section 6 introduces the SWOT analysis as well as the Service Marketing Mix and

applies these concepts to the ING - DiBa case study It illustrates how ING- DiBa

penetrated the German retail banking market with both the implementation of the

direct banking business model and the exploitation of external opportunities

Finally this thesis concludes with a summary of the major findings

5

2 Classification of Banks

21 Bank

This paper refers to banks as defined in the German Banking Act Section 1 GBA

defines financial institutes as enterprises which pursue banking transactions

insofar as the extent of these transactions requires commercial business operations

At least one of the following transactions has to be carried out security

transactions credit transactions payments transactions or other banking business

The enterprise which pursues banking transactions in Germany requires the

permission of the BaFin (Federal Institution for Finance Service Supervision)

according to section 32 GBA

22 Direct Bank

Direct banks are credit institutes which operate without a branch network and

utilize the internet and the telephone as direct communication channels through

which banking transactions are realized and marketing and customer service takes

place Thus direct banks establish cost advantages which they usually transmit in

the form of attractive terms15

23 Brick and Mortar Bank

A brick and mortar (BampM) company is a traditional street-side business that

deals with its customers face to face in an office that the company owns or rents16

A brick and mortar bank serves consumers in a physical facility as distinct from

providing online or telephone services only The term brick and mortar is not a

generally valid classification of a bank but in the jargon of e-commerce it is

frequently employed to distinguish from internet based enterprises In this thesis

the term brick and mortar bank is employed to differentiate between a direct bank

that operates through direct channels and one which operates solely through its

branch network The term brick and mortar is also distinguished from the term

click and mortar which is an expression for a form of multi-channel retailing in

15 Deutsche Bundesbank (2010) 16 Investopedia Dictionary (2010)

6

which both electronic distribution channels (click) and physical premises (mortar)

are utilized17

24 Multinational Bank

Multinational banks are defined as banks that have a physical presence in more

than one country In contrast international banks engage in cross-border operations

but do not establish a physical presence in foreign countries18

25 Retail Bank

There is no generally valid classification of retail banking in theoretical literature

or in practice19 A distinction in retail banking is often made with regard to its

target clientele In this regard some authors define retail banking as the offering of

banking and financial services to individuals and small and medium sized

enterprises20 Other sources define retail banking as the provision of these services

solely to individuals21 This paper employs the following classification of retail

banks `A retail bank is a bank that caters for ordinary individuals and small

business as distinct from large corporations Retail banking operations offer

deposit facilities lend money transfer funds and are prepared to deal in relatively

small amounts`22 In contrast to private and corporate banking retail banking

considers private clients with low to average income as well as small corporate

clients

2

Figure 1 Classification of retail banking clients

(own illustration based on Swoboda 2004)

17 Gabler Wirtschaftslexikon (2010) 18 Hersh and Weller (2002) 19 Muumlller and Joumlhnk (2005) 20 Pond (2007) FinanceWiki (2008) Tremblay and Tremblay (2007) 21 Frei Harker and Hunter (1998) Online Businessdictionarycom (2010) Investoglossarycom (2010) 22 Essvale Corporation Limited (2007)

Retail Banking

Medium and large corporate clients

Wealthy private clients

Small Corporate clients

Private clients

7

3 Market Entry Theories and Strategies

31 Transaction Costs Theory

In the transaction cost theory developed by Ronald Coase and Oliver E

Williamson a comparison of transaction costs determines the optimal form of

organization In TC Theory the entry mode decision is a tradeoff between the

control and the costs of resource commitment Entry modes vary in three major

aspects the cost of resource commitment control as the level of ownership and

environmental risks that may affect the committed resources Hence high-control

modes increase both risk and the potential return23

Williamson differentiates between ex-ante and ex-post transaction costs

Information and searching costs are incurred ex-ante in the process of collecting

market information and identifying suitable partners Negotiation and contract

costs arise ex-ante due to negotiations legal advisory and the determination of

contractual terms Monitoring costs develop ex-post for activities which serve to

control contractual obligations Conflict and enforcement costs arise ex-post due to

the different interpretation of the contract and the costs of enforcing contractual

regulations with sanctions negotiations or through court proceedings Adaption

costs are incurred due to ex-post changes in contractual agreements that become

necessary because of unpredictable developments24

TCE assumes the existence of bounded rationality and opportunism Bounded

rationality describes the limitation in human processing of information and the

planning of possible outcomes Opportunism describes the notion that humans may

act in a self-interested manner by manipulating information and being dishonest

The consequences of these assumptions are incomplete contracts and moral

hazards25 Vice versa opportunism occurs because firms can not write complete

contracts

The size of the transaction costs is determined in each case by the characteristics of

asset specificity uncertainty and frequency Asset specificity arises when the actor

in the market undertakes specific investments in order to fulfill his contractual 23 Chen and Mujtaba (2007) p322 24 Kieser and Ebers (2006) p278 25 Magill and Quenzii (1996) p11

8

obligations It refers to the degree to which long-lasting human or physical assets

are bound in a specific relationship and thus to the extent to which they provide

value in the context of a different situation26 In TCE markets can hardly solve the

problems that high uncertainty creates in combination with bounded rationality and

threats of opportunism Uncertainty includes environmental and behavioral

uncertainty Environmental uncertainty refers to political legal cultural and

economic uncertainties that may affect the success of business transactions

Behavioral uncertainty states that bounded rationality and the threat of opportunism

result in the high costs of monitoring a partner company27 If the similar

transactions are repeated frequently learning effects and economies of scale occur

and will reduce the transaction costs

32 Eclectic Theory

The eclectic theory28 (or OLI paradigm) was developed by John Dunning and is a

framework that merges different economic theories which explain foreign market

entry patterns of multinational corporations29 It states that the internationalization

of MNCs is determined by three sets of independent variables ownership

advantages (or firm- specific advantages) location advantages (or country specific

advantages) and internationalization advantages

The ownership advantage considers the competitive advantages of MNCs arising

from firm-specific characteristics such as size monopoly power economies of

scale management brand name technology and other resource capabilities30

These advantages are usually intangible assets and can be transferred at low costs31

The greater the competitive advantage of the MNC is the more likely it is able to

start or to increase its foreign production32

The location advantages arise from country specific benefits that can be divided

into three categories Firstly a host country may have economic advantages

comprising qualitative and quantitative factors such as production transports costs

26 Dietrich (1994) p18 27 Brouthers and Brouthers (2003) p1183 - 1185 28 Dunning (1980) Dunning (1988) Hill Kwang and Kim (1990) 29 Dunning (2002) 30 Forsbaeck and Oxelheim (2004) 31 Griffin and Pustay (2006) 32 Dunning (2002)

9

communication costs market size or tax incentives Secondly a host country may

offer political advantages in particular governmental policies that may influence

market entry Thirdly a host country may provide social and cultural advantages

including the psychic distance between the foreign and the domestic country as

well as language or cultural aspects that may have an impact on the market entry

decision The higher the attractions of the specific location the more likely it is that

MNCs will exploit their ownership advantage by entering the foreign market33

Because of the existence of transactions costs the internationalization incentive

advantage states that it must be profitable for the MNC to exploit these advantages

itself rather than through local companies (eg licensing)34

In economic literature the OLI paradigm has also been applied to the banking

sector In this regard ownership advantage may include easy access to a vehicle

currency Locational advantages may include country-specific regulations and

entry barriers Internationalization advantages can be information advantages and

access to local deposit bases35

Many empirical studies on the banking market have utilized the eclectic paradigm

as a basic framework For example a study of bank entry into CEE markets

concludes that the ownership advantages of foreign MNBs are strong compared to

banks in emerging markets and especially when the foreign country experiences a

banking crisis36 An application of the OLI paradigm to the Spanish banking

market has shown that bank size and multinational experience of MNBs favor

stronger commitment in the foreign country whereas distance is an entry barrier37

However theoretical literature also states that in service industries clients close to

the MNBs headquarters may be served from this location whereas clients in distant

markets require a physical presence of the MNB in the foreign country which

favors a foreign market entry with increasing distance38

33 Dunning (2002) 34 Hagen (1997) 35 Yannopoulus (1983) 36 Uiboupin and Sorg (2006) 37 Blandoacuten (1998) 38 Blondoacuten (1998) Terpstra and Yu (1988)

10

33 Strategy of Defensive Expansion

A common approach employed to explain the expansion of MNBs involves the

theory of defensive expansion which is also referred to as the acutefollow-the-

customeracute argument

This theory states that MNBs expand abroad in order to provide services for

domestic clients which are often large enterprises that have entered a foreign

market39 The provision of financial services in the foreign country usually requires

a presence at important economic centres Hence to some degree expanding

corporations impose pressure on their domestic banks to follow-up40

The term acutedefensiveacute is derived from the idea that a failure to expand may lead to a

loss of the client not only in the foreign country but also in the domestic one as

the client may associate with a foreign MNB41 Consequently MNBs which pursue

this strategy seek to prevent losses rather then to generate new profits in the foreign

market42 Furthermore the domestic bank has an incomparable competitive

advantage over banks in the foreign country with regard to the knowledge of

customer needs the respective risk of credit default as well as an interest in cross-

selling products such as financial advisory43

Due to earlier business relationships with the client the domestic bank has reduced

costs for examining the financial capacities of the respective enterprise and thus

can offer cheaper services44 Most foreign entry evidence supports the defensive

expansion theory45

A study on this theory with respect to retail banking has revealed that MNBs

sometimes expand abroad in order to provide banking services to specific

communities46

39 Trend im retail-banking koumlhler 40 Henneberger and Graf (2000) 41 Mullineux and Murinde (2003) 42 Naaborg (2007) 43 Knoop (2006) 44 Bhattacharya (1994) 45 Bhattacharya (1994) Naaborg (2007) 46 Tschoegl (1987)

11

34 Strategy of Offensive Expansion

MNBs that offensively expand abroad primarily seek to increase their customer

base both in the home and in the foreign country Firstly the establishment of

foreign branches and subsidiaries enables the MNB to expand their services to

domestic residents who benefit from the international orientation of the bank

These may include customers that have business partners in the foreign country

Secondly MNBs may target new customers in the foreign country in particular

MNEs or foreign subsidiaries of domestic enterprises As the MNB must in both

cases entice customers away from other banks the MNB has to offer attractive and

competitive conditions for their financial services47

47 Buumlschgen (1998) p604

12

4 Industry Analysis German Retail Banking Sector

41 Porter`s Five Forces

In the school of Industrial Economics the five-forces model has established itself

as a core element of industry analysis Porter`s analysis framework is built on the

following five market forces that shape the strategy of competitors threat of new

entrants threat of substitute products or services bargaining power of buyers and

suppliers as well as rivalry among existing competitors

Porterrsquos concept is based on the knowledge that the strategy of an enterprise must

orient itself to its market environment whereby the competitive strategy arises

from a differentiated understanding of the market structure and the knowledge of

how it changes The effects of these forces determine the intensity of the

competition in a market and with it its profitability and attractiveness Therefore

the aim of the enterprise strategy should be reflected in the search for possibilities

for the reduction or use of these competitive forces relative to its own enterprise In

this regard Porter`s model is conducive to the analysis of the driving forces

working in the respective industry

Figure 2 Michael E Porter`s five forces model (Own illustration based on Porter 1979)

Industry Rivalry

Threat of New

Entrants

Bargaining Power of

Buyers

Threat of Substitute Products

and Services

Bargaining Power of Suppliers

13

Porter`s framework is a useful and frequently utilized analytical tool to describe the

foundations of industry competition

A high degree of rivalry among the existing enterprises leads to high competitive

pressure and can lower profit margins and the profitability of individual

enterprises In situations in which a large number of enterprises target similar

market segments with comparable strategies in which the market grows slowly

price is the most important differentiation factor and high exit barriers exist a

negative impact on the industryrsquos profitability is effected48

The threat of new entrants can be determined by the entry barriers of a market The

competitive pressure on existing enterprises increases with low entry barriers In

such a situation important elements of the market (eg shares of the market price

level) can change due to the entry of new market participants49

The bargaining power of buyers determines to what extent customers can influence

enterprises by the amount of consumption and the pressure on margins Important

indexes of a high degree of buyer power include high fixed costs in the industry

existence of supplements of the product or service high degree of customer

concentration customers` knowledge of production costs possibility of a reverse

integration of customers high growth rates of the market and a strong

individualization of customer demand50

The bargaining power of suppliers affects industry profitability if for example a

concentrated supplier group dominates over existing enterprises in the market

which are not important buyers for the suppliers Then the industry faces high

margin pressure by the suppliers

A threat of substitute products and services exists in particular if cheaper or higher-

quality products and services are able to reduce existing sales volumes of a market

or an enterprise51 The future sales potential of existing enterprises becomes limited

and industry competition increases

48 Porter (1985) 49 Porter (1979) Recklies (2001) 50 Recklies (2001) 51 Recklies (2001)

14

Critics of this model state that it neglects the impact of complements as a sixth

force of the industry since they may facilitate or hinder the commercialization of

certain goods However Porter argues that complements are not a force itself but

they affect profitability in the way that they influence the five forces and that `the

strategist must trace the positive or negative influence of complements on all five

forces to ascertain their impact on profitability`52

One limitation of this model is based on studies which indicate that company-

specific factors may have a more important impact on profit than industry forces53

Furthermore the model suggests relatively static and stable market structure which

makes it difficult to assess contemporary dynamic markets54

The model does not assess the impact of the parent company on its subsidiary

which is especially important in the banking sector in which parent companies

often have a strong impact on the performance of their subsidiary or branch The

parenting advantage includes the stand-alone influence through monitoring and

influence on management decisions or capital expenses Furthermore parents

create value by enhancing synergies within the group offering corporate functions

or managing portfolios55

42 Rivalry among existing competitors

In this section the intensity of competitive rivalry among existing competitors in

the German retail banking sector is discussed In this regard an analysis of industry

structure industry growth and exit barriers will be conducted

Industry structure The German banking market is characterized by a three-pillar

system which is reflected by the strict distinction between public-law banks

cooperative banks and private banks56 Each pursues different goals and is subject

to different regulations Private commercial banks pursue the goal of profit

maximization whereas saving banks serve the public contract of offering secure

52 Porter (1997)p11 53 Zack (1999) 54 Recklies (2001) 55 Goold Cambpell and Alexander (1994) 56 Gramlich (2005)

saving possibilities and loans C

interest of their members

banking market is structured as follow

Figure 3(own illustration based on Sch

Public-law banks including saving banks and state banks

total balance sheet volume of banks in Germany

do not participate in retail banking The cooperative bank sector amounts to 11

the total including cooperative banks

cooperative central banks

commercial banks including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

31 of total balance sheet volume

European Research (ZWE) 43 of experts state that the three

important or very important and

for the low number of cross

In order to describe industry rivalry among maj

retail sector the following table illustrates the number of customers per bank in

Germany

57 Engerer (2006) 58 Koumlhler (2008b)

banks 24

Private commercial banks 31

15

possibilities and loans Cooperative banks primarily serve the economic

interest of their members57 In terms of total balance sheet volume the German

banking market is structured as follows

Figure 3 Structure of the German Banking Sector(own illustration based on Schrooten 2009)

law banks including saving banks and state banks amount to 33 of the

total balance sheet volume of banks in Germany However state banks

do not participate in retail banking The cooperative bank sector amounts to 11

including cooperative banks which participate in retail ban

cooperative central banks which primarily serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

alance sheet volume According to a recent survey of the Center for

European Research (ZWE) 43 of experts state that the three-pillar system is

important or very important and 33 state that it is the critical factor responsible

cross-border mergers and acquisitions in Germany

In order to describe industry rivalry among major banks that participate in the

the following table illustrates the number of customers per bank in

Savings banks 13

State banks 20

Cooperative central banks

3Credit cooperative banks 8

Other banks 24

serve the economic

sheet volume the German

Structure of the German Banking Sector

amount to 33 of the

However state banks generally

do not participate in retail banking The cooperative bank sector amounts to 11 of

participate in retail banking and

serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks amount to

According to a recent survey of the Center for

pillar system is

33 state that it is the critical factor responsible

border mergers and acquisitions in Germany58

or banks that participate in the

the following table illustrates the number of customers per bank in

State banks 20

Cooperative central banks

16

Figure 4 Customers of German Banks at the end of 2007 in millions (own illustration based on Deutsche Bank 2008)

With approximately 50 million customers savings banks are the market leader in

the German retail banking sector Although state liability assumption for savings

banks was abolished in 2005 because the EU saw in it an unacceptable subsidy to

the disadvantage of private banks customers still associate the name `Sparkasse`

with state guarantees The specific characteristic of a saving bank is based on its

public contract in that it has to accept customers with poor credit-worthiness that

profits should be used to enhance public wealth and that the middle class should be

supplied with loans59

With approximately 30 million customers cooperative banks are the second major

player in the German retail banking sector Nearly half of these customers are

members of the cooperative banks60 In contrast to the profit maximization goal of

private commercial banks their aim is to fund their members and secure their

economic independence Although cooperative banks are economically and legally

independent in the different regions they appear uniformly as a group under the

brand of ldquoVolks- und Raiffeisenbankenrdquo With regard to growth in customer base

cooperative banks benefit from the advantage of having the regional flexibility that

59 Kruck (2008) 60 Online Raiffeisen Bank Homepage

31

4

61

118

242

30

50

0 10 20 30 40 50 60

Citibank

Hypovereinsbank

ING DiBa

Commerzbank and Dresdner Bank

Postbank and Deutsche Bank

Credit Unions (Volksbanken)

Savings Banks (Sparkassen)

17

allows for topical advertisement as well as a centralized management focus on

improving reputation61

The third group comprises the major private commercial banks including Deutsche

Bank Postbank Commerzbank and Hypovereinsbank Deutsche Bank is a leading

multinational investment bank but with relatively low market share in the retail

banking market Deutsche Bank (97 million clients) is acquiring Postbank (145

million clients) with its broad branch network in a three-step process Together

they have 242 million clients However Heino Ruland from the analyst company

Frankfurt Finanz Partner argues that Deutsche Bank might not be able to capitalize

on the financially weaker Postbank clients as Deutsche Bank is specialized in

corporate clients62 With regard to rivalry intensity and market profitability Rainer

Neske supervisory board member and head of private amp business clients of

Deutsche Bank emphasizes that the German retail banking market is too

fragmented to be highly profitable and that Deutsche Bank does not seek to

compete on the price level but defines itself through performance quality and

consultancy63

Commerzbank is the second largest private commercial bank in Germany After the

acquisition of Dresdner Bank in 2009 Commerzbank now serves more than 12

million clients (of these 11 million private and one million corporate clients) and

pursues the goal of becoming the market leader in Germany64

UniCredit Bank AG with the brand name Hypovereinsbank (HVB) is a subsidiary

of UniCredirSpA and is the third largest private commercial bank in Germany

HVB serves approximately four million clients predominantly in north Germany

and in Bavaria As its retail banking segment could only report marginal profits in

2009 speculation about a sale or acquisition in this segment has come up As the

Swedish SEB (Skandinaviska Enskilda Bank) is considering selling its German

retail segment with 174 branches and one million clients experts now regard HVB

as a major buying candidate65

61 Schwarzbauer (2009) 62 Kreiler (2008) 63 Deutsche Bank (2009) 64 Kreiler (2008) 65 Houmlpner and Nagl (2010)

18

ING DiBa AG is a subsidiary of the Dutch ING Group and serves over 6 million

clients In contrast to savings cooperative and the major private commercial

banks ING DiBa is specialized in direct banking which distributes services via

telephone the internet or post instead of through branches In Germany ING

DiBa is the leader in direct banking but there are many other direct banks such

as Comdirect (a subsidiary of Commerzbank) Volkswagen Bank or DAB Bank

(a subsidiary of HVB) Competition takes place not only among direct banks but

also between direct and branch banks For instance many saving banks have

blocked the opportunity for customers of direct banks to withdraw cash from their

automated teller machines As savings banks can only charge Euro 174 for

withdrawals via visa cards they fear that direct banks can gain market share by

offering attractive account options with a convenient wide-area ATM provision66

Targobank (former Citibank Deutschland) was acquired by the French

cooperative bank Creacutedit Mutel and now serves more than 34 million clients in

Germany in 2010 The bank is specialized in private retail customers with

branches and direct banking67

In conclusion the degree of concentration in the German retail banking market is

very low which reduces the overall profitability of this sector for two main

reasons Banks earn higher profits in concentrated markets as they obtain either

monopoly rents (structure-conduct-performance paradigm) or due to high market

shares that are gained by more efficient and profitable banks (efficient structure

hypothesis)68 As retail banking services are largely standardized product

differentiation is low and price differentiation is often the only option As public-

law banks serve other interests than profit maximization existing private banks

and MNBs that want to enter this market have a competitive disadvantage The

low switching costs of clients intensifies competition on the price level and thus

reduces the profitability of the market However brand identification and

customer relationships are also important which decreases the willingness of

clients to switch solely on the basis of price comparison In summary market

structure indicates a very high degree of rivalry among existing competitors

66 Online Financial Times Deutschland (2010) 67 Targobank (2010) 68 Havrylchyk and Jurzyk (2006) p15

19

Industry growth In this section industry growth will be examined in a dynamic

analysis of three relevant market growth indicators the future long-run

development of the German population the historical development of the number

of banks and branches in Germany and the historical development of market-

share allocation in the context of major retail banking activities

In the long-run market growth depends on the future numerical development of

the market`s customers - the German population As the growth of population

through birth and immigration is smaller than its decrease by virtue of the mortality

rate and emigration the Federal Statistical Office in Germany estimates a sharp

decline of the German population

Figure 5 Estimated Development of German Population (in millions)

(Federal Statistical Office 2009)

The Federal Statistical Office predicts that the trend of decline in population since

2003 will continue and intensify Whereas approximately 82 million people lived

in Germany in 2008 only between 65 million (average lower limit of the

population with 100000 immigrants yearly) and 70 million people (average

upper limit of the population with 200000 immigrants yearly) will reside in

Germany in 2060 Furthermore the decreasing number of births and the ageing of

the current strongly represented middle age group will lead to substantial changes

in the age structure of the population From 2008 to 2060 the proportion of people

from 65 to 80 years will increase 15 to 20 and the proportion of people over

80 years of age will increase from 5 to 14 of the population69 The

69 Federal Statistical Office (2009)

Average lower limit

Average upper limit

20

implications of the aging population for banks will be discussed in the comparison

between direct banks and BampM banks in section 66 of this thesis

The second indicator of industry growth deals with the number of banks and bank

branches in the German market The overall number of banks in Germany

decreased from 3785 in 1995 to 2300 in 2006 As retail banking usually depends

on the number branches maintained their development in Germany will be

examined

Figure 6 Development of Total Bank Branches in Germany (own illustration based on Koumlhler2008a)

Savings banks and cooperative banks have reduced the number of branches

significantly Public-sector banks (savings banks state banks etc) with 18757

branches and cooperative banks with 16028 branches in 1998 reduced the

number of branches to 14252 and 12303 respectively in 2006 Moreover the

number of branches of major commercial banks decreased from 19055 in 1998 to

8879 in 2006

The main cause for the decrease of branches is the high fixed costs which can not

be recouped from low-revenue standard products that can also be distributed

through alternative low-cost channels such as the internet70

70 Koumlhler and Land (2008)

67930 6666363186

59929 58546 5693653931

5086847244 45467 44100

40332

0

10000

20000

30000

40000

50000

60000

70000

80000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

21

As a third indicator of industry growth this paper reflects on the allocation of

market share within the retail banking sector in order to indentify trends that may

affect overall market growth This paper will reflect on market share in two major

retail banking segments - savings deposits and loans The German Central Bank

classifies the banking market in terms of savings banks cooperative banks direct

banks and credit banks The latter include universal banks which are private

commercial banks branches of foreign banks regional banks and other private

banks

This section reflects the development of market share regarding short- medium-

and long-term saving accounts and examines the allocation of loans to corporate

clients consumers (consumer loans) private households and self-employed

persons

In the period from 1998 to 2006 the market for medium-term saving deposits with

a cancellation period under three months has been dominated by saving banks (53

market share in 2006) and cooperative banks (29 market share in 2006) In the

same period the market share for long-term saving deposits with a cancellation

period above three months has also continuously been dominated by savings banks

(65 market share in 2006) and cooperative banks (24 market share in 2006)

However with regard to deposits that mature daily direct banks were able to

increase market share from approximately 15 in 1998 to over 15 in 2006

Figure 7 Market share development of saving accounts that mature daily (own illustration based on Deutsche Bundesbank 2007)

000

500

1000

1500

2000

2500

3000

3500

4000

4500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Banks

Cooperative Banks

Savings Banks

Credit Banks

22

From 1998 to 2006 market share for loans for corporate clients has been

continuously dominated by credit banks (53 market share in 2006) and savings

banks (34 market share in 2006) However this data also comprises loans for

medium and large corporations which are not part of the retail banking market

Loans for private households and self-employed persons have predominately been

granted by savings banks (39 market share in 2006) credit banks (30 market

share in 2006) and cooperative banks (25 market share in 2006) though direct

banks were able to gain some market share from 0 in 1998 up to 5 in 2006

Even more significantly direct banks were able to gain over 16 market share in

the segment of consumer loans

Figure 8 Market share development of consumer loans (own illustration based on Deutsche Bundesbank 2007)

Hence the most significant growth indicator of the retail banking market results

from the emergence of direct banks which were able to gain substantial market

share in consumper loans and deposits that mature daily

In conclusion the industry growth analysis indentifies the following growth

indicators Firstly a sharp decrease in the German population in the following

decades will reduce growth and increase industry rivalry Moreover the

demographic change increases the proportion of old people in the population

Secondly the number of branches in Germany is decreasing due to high fixed

costs of branches In order to be profitable in retail banking the existing branches

must serve a large quantity of customers which leads to strong competition

relative to market share Thirdly the development of market share allocation

000

1000

2000

3000

4000

5000

6000

7000

2002 2003 2004 2005 2006

Savings Banks

Cooperative Banks

Direct Banks

Credit Banks

23

indicates that only direct banks have experienced significant growth from 1995 to

2006

Exit barriers From a perspective of Transaction Costs Economics one can argue

that exit barriers in branch banking are high for market participants as branches

and staff are highly specific assets that lose value when used in another situation

To a large extent these assets are locked into the context of retail banking

Moreover public-law banks usually have to serve the population regardless of

whether they are profitable or not In a situation in which a bank continuously

experiences losses staff and branches may be considered as sunk costs and thus

economically `irrationalacute exit barriers However theories suggest that staff and

branches are practically valid exit barriers and cause MNCs to stay in a market71

The high degree of exit barriers intensifies the strong rivalry among existing

competitors

43 Threat of New Entrants

New entrants usually seek to gain market share while applying pressure on prices

and costs and thus increasing the investments necessary to compete An expert

survey conducted by the ZEW emphasizes the importance of entry threat to the

German retail-banking market 6666 of market experts state that new

competitors (eg foreign banks) have an important or a very important impact on

industry rivalry72

In this section the threat of new entrants to existing market participants in the

German retail banking sector is discussed In this regard this section evaluates

legal entry barriers capital requirements the necessity of large scale operations

customer switching costs and incumbency advantages of existing domestic banks

Legal entry barriers are determined by governmental regulations in the German

Banking Act (GBA) and are supervised by the Federal Supervisory Authority73

According to section 32 para 1 (1) GBA companies that intend to pursue

commercial banking transactions or financial services in Germany require written

71 Hill Hwang and Kim (1990) 72 Koumlhler and Lang (2008) 73 Bundesanstalt fuumlr Finanzdienstleistungsaufsicht (2005)

24

permission from the Federal Financial Supervisory Authority ( ldquoBundesanstalt fuumlr

Finanzdienstleistungaufsichtrdquo) The execution of banking transactions or financial

services also exists when the operator has its headquarters or primary residence

abroad but repeatedly targets companies or individuals who have their primary

residence in Germany In order to obtain the permit several requirements are

examined (eg business plan qualified management etc)

Companies from third countries which intend to conduct banking transactions and

provide financial services in Germany must establish a subsidiary (section 32 para

1 in connection with ection 33 para 1 (6) GBA) or a branch (section 32 para 1 in

connection with section 53 GBA) in Germany Companies from third countries can

apply for an exemption according to section 2 para 4 GBA if the company is

supervised utilizing international accounting standards in the home country and the

responsible authority works together with the BaFin According to section 53b

GBA companies of EEA states are allowed to establish branches (section 53b para

2) but are also free to conduct cross-border financial services without a domestic

presence (section 53b para 2a) Section 32 para 1 GBA does not apply to business

that is motivated by the initiative of the domestic individual or enterprise (so called

passive service freedom)

Representations are limited to their representative function and are not allowed to

conduct or initiate any banking business

Capital requirements are low for cross-border lending and and relatively low for

representations With high equity modes such as branches and even more so with

subsidiaries capital requirements are relatively high as capital is required for

building a broad network of facilities and offering credit to customers Capital

requirements for direct banks are relatively low compared with those of BampM

banks

The necessity of large scale operation is related to the competitive advantage of

economies of scale A company that serves the market in the context of larger

quantities benefits from lower cost per unit In retail banking profit is gained by

having a large number of clients It is expensive to build up these numbers and to

establish a distribution network to serve them This necessity relates directly to the

strategy of the bank An acquisition offers a shortcut to these facilities although the

25

costs of integration can be high as well74 A MNB may also decide to target only a

certain geographical area with certain clients and therefore do not have to enter on

a very large scale

Customer switching costs are different for each individual In general customers

can easily change their banks and open a deposit account or apply for a loan at

another bank However they have to compare the different terms for usually small

transactions to evaluate the convenience of having a bank nearby and then to

decide to terminate the relationships with their current bank75

Finally the incumbency advantages of existing banks are important entry barriers

In particular they include established brand reputation possession of the most

favorable geographical locations and market knowledge Moreover established

banks may already have exclusive contracts with SMEs76

To conclude legal entry barriers are low and particularly low for banks from the

EEA Capital requirements for entering the market are high yet as far as equity

entry modes are concerned direct banks require relatively low capital as they

distribute their services through low-cost channels Banks need to attract many

customers to be profitable but banks strategy dictates whether or not to entrance

should occur on a large scale Moreover the incumbency advantages of existing

banks constitute important entry barriers

44 Threat of Substitute Products or Services

A substitute in retail banking is a service that offers an attractive trade-off to a bank

service or product As individuals and small firms do not regularly report financial

information as do large enterprises they rely primarily on bank lending However

there are additional forms of financing in the private equity or dept market77

Many non- and near- banks provide substitute products and services Near-banks or

quasi-banks are suppliers of financial services but are not classified as credit

institutes according to section 1 GBA Near-banks such as insurance companies or

credit card organizations however do provide substitute products or services Non-

74 Hughes and MacDonald (2009) 75 Adams (2002) 76 Adams (2002) 77 Xiaoqin and Terada-Hagiwara (2003)

26

banks such as department store chains catalog companies or car producers also

provide substitute services78 For instance instead of taking out a loan in order to

pay for a product individuals or small enterprises may decide to take on a leasing

contract for a certain asset or small enterprises can obtain a trade credit as well

Individuals may decide on buying products from insurance companies instead of

putting money into a bank account

Another substitute for both direct and BampM banks is the person-to-person (p2p)

lending business a new form of borrowing and lending money that takes place in a

web-based market place In this online platform borrowers are connected to

lenders through an auction-like process in which a lender who bids to provide a

loan for the lowest interest rate will be awarded the loan contract with the

borrower A p2p company mediates between private or company borrowers and

lenders and also executes transactions between the parties similar to the role which

e-bay plays in the trade of commercial goods79 The p2p lending business does not

involve traditional banks and thus can offer superior interest rates to borrowers and

higher returns for lenders

45 Bargaining Power of Suppliers

When a supplier group is more concentrated than the industry does not primarily

depend on the industry and when the industry faces high switching costs the

supplier group has strong bargaining power and can reduce the profit potential of

an industry In the retail banking market the most relevant suppliers include human

resources suppliers of capital resources and suppliers of information and

communication technology (ICT)80 Highly talented or experienced specialists are

strongly canvassed and have strong bargaining power with respect to their salary

and working conditions However in the aftermath of the financial crisis many

banks are planning a reduction of staff According to a study of Ernst amp Young

every fifth bank intends to decrease staff and only every 10th bank is planning an

increase81 Given the current situation of the employment market the bargaining

power of employees is relatively low Suppliers of highly specialized banking ICT

78 Gabler Wirtschaftslexikon (2010) 79 Deloitte (2009) p 12 80 Buumlschgen and Boumlrner (2003) 81 Ernst amp Young (2009)

27

solutions have strong bargaining power as switching costs for these systems are

very high Moreover the higher yield requirements of shareholders can be

interpreted as supplier power

46 Bargaining Power of Buyers

In retail banking there are many buyers with relatively low transaction volumes

which weakens their bargaining power However retail banking services are

standardized and buyers can easily find similar services Switching costs have

usually been relatively high for these low volume transactions but in the age of the

internet the market is very transparent and buyers can screen different offerings

more easily This does not necessarily imply that the cheapest banking service will

be chosen automatically as customers also seek a trustworthy brand especially in

times of financial crisis Moreover there are other factors that affect the switching

cost of the individual such as the location of the branch Yet there is a tendency

towards the increasing bargaining power of buyers

This is also substantiated by the ZEW survey 7984 of market experts state that

decreasing customer loyalty and increasing price sensibility are important or very

important factors with respect to the intensity of competition in the German retail

banking sector A comparison of former and modern retail customers also indicates

that the bargaining power of retail banking service users has increased

Former Retail Customer Modern Retail Customer

Passive information seeking

behavior

Active information seeking behavior

Hardy or little informed Good to very good know-how

High customer loyality Increasing willingness to switch

Fixation on the branch Expects multi-channel banking at all times

and places

Little market transparency High price transparency

Relatively undemanding Demanding

Figure 9 Comparison of former and modern retail customers (own illustration based on Swoboda 2004)

28

5 Foreign Bank Entry Strategies in Germany

This section illustrates mode choices for foreign bank entry in Germany Based on

the hierarchical model of market entry modes82 the foreign bank has the choice of

equity and non ndash equity modes of entry An advantage of the hierarchical model is

that it allows comparing between entry modes on different levels The main

difference between equity and non ndash equity modes is the degree of resource

commitment in the foreign country As classified at the beginning of this thesis

non-equity entry refers to international banking and equity entry refers to

multinational banking

The research question of this thesis considers multinational bank entry modes

International banking however is often a first step towards multinational banking

Hence this thesis will also discuss cross-border lending and alliances as non ndash

equity entry modes The following figure illustrates a comprehensive view of

market entry modes for banks

Figure 10 A hierarchical model of entry mode choices for banks (own illustration based on Pan and Tse 2000)

82 Pan and Tse (2000)

Entry Mode Choices

Non - Equity Modes

Export

Cross Border Lending

Contractual Agreements

Alliances

Equity Modes

Equity Joint Ventures

Greenfield Investment

Branch

Subsidiary

Representation

Acquisition

Subsidiary

Branch

29

The hierarchical model illustrates the various entry mode choices for entering the

German retail banking market The creation of a common European financial

market in which banks can integrate freely is a major goal of the European Union83

The previous section of this paper indicates that entry barriers are relatively low

and that the German market is highly competitive Hence the choice of a proper

entry mode which is appropriate to the capabilities and the strategy of the bank is

even more significant Therefore the following section will reflect on the strategic

concept governing the choice of entry modes as well as the proliferation of these

entry modes in the German retail banking market

An international bank that is not interested in investing equity in the foreign

market can enter by means of cross-border lending or by forming a non-equity

alliance These non-equity entry modes can help the bank to access niche markets

or to exploit locational advantages when the bank is located near the German

border

However a retail bank defined in the beginning of this paper as a bank that

`caters for ordinary individuals and small businessacute and that seeks to enter the

German market in order to gain significant revenue from deposits and loan

business might have to consider a physical presence in the foreign country

The analysis considers entry modes that are perceived as international banking

cross-border lending and non-equity strategic alliances Furthermore the equity

modes JVs and representations will be discussed

Subsequently this section compares the market entry of a branch through

Greenfield investment with the market entry of a subsidiary by virtue of

acquisition as these modes of entry are the most common in the German retail

banking market

Finally the following question will be addressed to what extent do demographic

and technical trends favor a direct bank entry mode over a brick and mortar bank

approach in Germany

83 Fidrmuc and Hainz (2008)

30

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks (own illustration)

51 Non ndash equity modes Export ndash Cross-Border Lending

Cross-border lending is equivalent to the export entry mode and is a simple non-

equity strategy to enter a foreign market A bank which participates in cross-

border lending must assess the creditworthiness of the individual borrower as well

as the country risk which involves the possibility that these loans will be impaired

by economic or political proceedings in the foreign country84 The country risk in

Germany is rather low as it is perceived to have a solid political and economic

situation (Country Rating A2) with a stable and a very efficient business

environment (Country Rating A1)85 As a bank will only have limited access to soft

information about the creditworthiness of the borrower the availability of loans

usually decreases and the interest on loans usually increases with distance86 Soft

information for private loans includes the previous experience with the account

management of the credit user environmental facts and a judgment relative to his

employment contract87 For corporate loans soft facts may include the market

environment corporate structure management a business plan as well as

84 Hughes and McDonald (2003) 85 Online wwwtrade-safelycom (2009) 86 Agrawal and Hauswald (2007) 87 Dizil (2009)

Entry Mode Choices of MNBs

Greenfield Investment

Branch

Brick and Mortar Bank Direct Bank

Acquisition

Subsidiary

Brick and Mortar Bank Direct Bank

VI

Table of contents

List of Figures VIII

List of Abbreviations IX

1 Introduction 1

11 Research Objective 2

12 Structure 2

2 Classification of Banks 5

21 Bank 5

22 Direct Bank 5

23 Brick and Mortar Bank 6

24 Multinational Bank 6

25 Retail Bank 6

3 Market Entry Theories and Strategies 7

31 Transaction Costs Theory 7

32 Eclectic Theory 8

33 Strategy of Defensive Expansion 10

34 Strategy of Offensive Expansion 11

4 Structure Analysis German Retail Banking Market 12

41 Porter`s Five Forces 12

42 Rivalry Among Existing Competitors 14

43 Threats of New Entrants 23

44 Threats of Substitutes 25

45 Bargaining Power of Suppliers 26

46 Bargaining Power of Buyers 27

5 Foreign Bank Entry Strategies in Germany 28

51 Cross-border lending 30

52 Alliances 31

VII

53 Joint Ventures 32

54 Representations 33

55 Entry Mode Choice Greenfield-Branch vs Acquisition-Subsidiary 34

56 Business Model Choice Direct Bank vs Brick and Mortar Bank 38

561 Demographical Trends 40

562 Technological Trends 42

6 Case Study ING DiBa 45

61 Corporate Profile ING Group 45

62 Market Entry and Market Penetration 45

63 SWOT Analysis 46

64 ING DiBa SWOT Analysis 48

641 Strengths 48

642 Weaknesses 48

643 Opportunities 49

644 Threats 49

65 The Service Marketing Mix 50

66 ING DiBa Marketing Mix (7Ps) 52

67 Summary 55

7 Conclusion 56

Literature

Appendix

VIII

List of Figures

Figure 1 Classification of retail banking clients 6

Figure 2 Michael E Porter`s Five Forces model 12

Figure 3 Structure of the German banking sector 15

Figure 4 Customers of German banks at the end of 2007 (in millions) 16

Figure 5 Estimated development of the German population (in millions) 19

Figure 6 Development of total bank branches in Germany 20

Figure 7 Market share development of accounts that mature daily 21

Figure 8 Market share development of consumer loans 22

Figure 9 Comparison of former and modern retail banking customers 27

Figure 10 A hierarchical model of entry mode choices for banks 28

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks 30

Figure 12 Development of foreign MNBs branches in Germany 35

Figure 13 Development of foreign MNBs subsidiaries in Germany 37

Figure 14 SWOT analysis 47

Figure 15 Service Marketing Mix 51

IX

List of abbreviations

ATM Automated Teller Machine

BampM Brick and Mortar

CEE Central and Easter European

EEA European Economic Area

FDI Foreign Direct Investment

GBA German Banking Act

ICT Information and Communication Technology

JV Joint Venture

MNB Multinational Bank

MNE Multinational Enterprise

RDC Remote Deposit Capture

SMEs Small and Medium Sized Enterprises

TCE Transaction Costs Economics

WOS Wholly Owned Subsidiary

ZEW Centre for European Economic Research

1 Introduction

In the aftermath of the recent financial crisis1 and in times in which banks

rediscover the private individual ndash also described as the renaissance of retail

banking2 - significant attention is now being paid to the market entries of foreign

multinational banks3

The German retail banking market is highly competitive Private cooperative and

state-controlled savings banks compete intensely for market share with hardly any

cooperative activities among the groups As savings banks are owned by German

states towns or local authorities they are protected by law from takeovers by

institutes from the other banking sectors4 Due to the high fragmentation of the

German market hardly any bank has dominant market power The five largest

banks have a total market share of only 20 percent and new competitors enter the

market and attract customers with aggressive price differentiation offers5 The

strong competition among private banks savings banks and co-operative banks

results in low profit margins by international comparison The profit potential in

German private-customer business has fallen for many years From 2000 to 2006

total income from the financial service providers in Germany measured by the

distribution of financial products with private customers fell approximately 15

from euro 675 billion to euro 574 billion6 Though the retail banking sector has

experienced some increase in profits due to cost reduction and reduced loan

failures in 2007 market potential still stagnated in 20097

Since the financial crisis has raised the awareness of the threats of investment

banking many banks have refocused on core business activities in order to

maintain their solvency through increased account deposits Banks need money to

grant loans to private individuals or enterprises provide investment opportunities

finance consumer goods or simply realize baking transactions Yet the recent

financial crisis caused distrust among the banks and loans will not be granted as

1 Plickert (2009) 2 Deutsche Bank (2009) 3 Koumlhler and Lang (2008) 4 Spiegel Online (2007) 5 Welp (2009) 6 Zebrolfesschierenbeckaccosiates (2008) 7 McKinsey amp Company (2007) Zebrolfesschierenbeckaccosiates (2008)

2

easily as before On the consumer side the financial crisis has increased the

demand for secure money investments A survey of 230 highly ranked managers

from private savings and co-operative banks on the effects of the crisis on their

business indicates that banks have concentrated more intensively on business with

private customers both during and after the latest crisis Moreover customer

demand for certificates company shares or funds has fallen significantly while the

demand for standard retail banking products such as call money accounts or

account books has increased substantially8

In spite of its high competitiveness and low profit margins the German retail

banking market is still attractive for foreign banks Foreign MNBs are increasingly

able to penetrate the market for private individuals9 In particular they gain market

share through new products decreasing prices standardized processes and

innovative marketing whereas domestic banks have often relied on continued

customer loyalty10 Although foreign multinational banks in Germany have usually

concentrated on large domestic corporations engaged in international

transactions11 they now enter the market for private and small corporate clients as

well12- a trend that has been supported by the development of internet technology

and other new marketing - channel options

The distinctive characteristics of the German banking market raise several

questions concerning both entry mode and business model considerations of

multinational banks Should a multinational bank engage in cross-border lending or

rather enter the market via foreign direct investment How do the development of

economic political-legal and social-cultural factors in the German market affect a

multinational bank`s entry mode and business model choice

This thesis distinguishes between the non - equity entry modes of cross-border

lending and alliances as well as the equity entry modes of representative offices

branches subsidiaries and JVs both from a Greenfield investment and an

acquisition point of view Each of these organizational entry mode forms has

8 Welp (2009) 9 Reitz (2005) 10 McKinsey amp Company (2007) 11 Hersh and Weller (2002) 12 Koumlhler (2008)

3

distinctive advantages and disadvantages Hence the main focus of this thesis is to

provide a broad understanding of the distinctive market entry and penetration

strategies in light of macro and micro economical developments in Germany

11 Research Objective

This thesis examines entry mode choice decisions and business model

considerations of multinational banks entering the German retail banking sector

The objective is to evaluate the affect of current market developments on their

entry mode decisions

In light of the financial crisis and the banks` rediscovery of the private individual

the German banking sector is currently experiencing a renaissance resulting in

increasing industry rivalry At the same time the processing of bank transactions

and customer services is becoming increasingly independent of the branch

distribution channel and the adoption of new technologies is substantially affecting

the allocation of retail banking services13 The technological evolution is

exemplified by the emergence of web-based direct banks which have been able to

penetrate the retail banking market with low-cost structures innovative ideas and

distinctive service thinking

Eventually the growing importance of the internet and other technological means

as distribution channels on the one hand and the remaining strong demand for

personal consultation on the other hand require a customer-oriented multi-channel

management of the banks14

This paper contrasts the two opposing ends in the field of retail banking

distribution channels It simplifies the entry mode choice between direct banks that

solely operate through the internet and brick amp mortar banks which solely operate

through a branch network Furthermore it differentiates between branch entry via

Greenfield investment and subsidiary entry via acquisition

Two major questions will be addressed

13 Deloitte (2010) 14 Welp (2009)

4

Firstly to what extent do demographic and technical developments favor a direct

bank entry mode over a brick and mortar bank approach in Germany

Secondly what affects the decision in favor of a branch entry mode via Greenfield

investment as compared to a subsidiary entry mode via acquisition in Germany

12 Structure

This thesis is systematically divided into two different complexes - a theoretical

and a practical After a classification of essential banking terms in the section 2

Section 3 then describes relevant market entry theories ndash namely the Transaction

Costs Theory and the Eclectic Theory as well as market entry strategies ndash namely

the offensive and the defensive strategies of expansion

In section 4 the German retail banking market is analyzed within the five forces

framework The goal of this examination is to evaluate market attractiveness and to

identify micro and macroeconomic developments that may shape the market in the

future

Given the theoretical framework of section 3 and the knowledge of industry

structure and trends of section 4 section 5 explores the decision driving factors of

entry mode choice In this section cross-border lending alliances joint ventures

and representations will be discussed Furthermore this section indicates what

affects the decision in favor of a branch entry mode via Greenfield investment as

compared to a subsidiary entry mode via acquisition and to what extent

demographic and technical developments favors a direct bank entry mode over a

brick and mortar bank entry mode in Germany

Section 6 introduces the SWOT analysis as well as the Service Marketing Mix and

applies these concepts to the ING - DiBa case study It illustrates how ING- DiBa

penetrated the German retail banking market with both the implementation of the

direct banking business model and the exploitation of external opportunities

Finally this thesis concludes with a summary of the major findings

5

2 Classification of Banks

21 Bank

This paper refers to banks as defined in the German Banking Act Section 1 GBA

defines financial institutes as enterprises which pursue banking transactions

insofar as the extent of these transactions requires commercial business operations

At least one of the following transactions has to be carried out security

transactions credit transactions payments transactions or other banking business

The enterprise which pursues banking transactions in Germany requires the

permission of the BaFin (Federal Institution for Finance Service Supervision)

according to section 32 GBA

22 Direct Bank

Direct banks are credit institutes which operate without a branch network and

utilize the internet and the telephone as direct communication channels through

which banking transactions are realized and marketing and customer service takes

place Thus direct banks establish cost advantages which they usually transmit in

the form of attractive terms15

23 Brick and Mortar Bank

A brick and mortar (BampM) company is a traditional street-side business that

deals with its customers face to face in an office that the company owns or rents16

A brick and mortar bank serves consumers in a physical facility as distinct from

providing online or telephone services only The term brick and mortar is not a

generally valid classification of a bank but in the jargon of e-commerce it is

frequently employed to distinguish from internet based enterprises In this thesis

the term brick and mortar bank is employed to differentiate between a direct bank

that operates through direct channels and one which operates solely through its

branch network The term brick and mortar is also distinguished from the term

click and mortar which is an expression for a form of multi-channel retailing in

15 Deutsche Bundesbank (2010) 16 Investopedia Dictionary (2010)

6

which both electronic distribution channels (click) and physical premises (mortar)

are utilized17

24 Multinational Bank

Multinational banks are defined as banks that have a physical presence in more

than one country In contrast international banks engage in cross-border operations

but do not establish a physical presence in foreign countries18

25 Retail Bank

There is no generally valid classification of retail banking in theoretical literature

or in practice19 A distinction in retail banking is often made with regard to its

target clientele In this regard some authors define retail banking as the offering of

banking and financial services to individuals and small and medium sized

enterprises20 Other sources define retail banking as the provision of these services

solely to individuals21 This paper employs the following classification of retail

banks `A retail bank is a bank that caters for ordinary individuals and small

business as distinct from large corporations Retail banking operations offer

deposit facilities lend money transfer funds and are prepared to deal in relatively

small amounts`22 In contrast to private and corporate banking retail banking

considers private clients with low to average income as well as small corporate

clients

2

Figure 1 Classification of retail banking clients

(own illustration based on Swoboda 2004)

17 Gabler Wirtschaftslexikon (2010) 18 Hersh and Weller (2002) 19 Muumlller and Joumlhnk (2005) 20 Pond (2007) FinanceWiki (2008) Tremblay and Tremblay (2007) 21 Frei Harker and Hunter (1998) Online Businessdictionarycom (2010) Investoglossarycom (2010) 22 Essvale Corporation Limited (2007)

Retail Banking

Medium and large corporate clients

Wealthy private clients

Small Corporate clients

Private clients

7

3 Market Entry Theories and Strategies

31 Transaction Costs Theory

In the transaction cost theory developed by Ronald Coase and Oliver E

Williamson a comparison of transaction costs determines the optimal form of

organization In TC Theory the entry mode decision is a tradeoff between the

control and the costs of resource commitment Entry modes vary in three major

aspects the cost of resource commitment control as the level of ownership and

environmental risks that may affect the committed resources Hence high-control

modes increase both risk and the potential return23

Williamson differentiates between ex-ante and ex-post transaction costs

Information and searching costs are incurred ex-ante in the process of collecting

market information and identifying suitable partners Negotiation and contract

costs arise ex-ante due to negotiations legal advisory and the determination of

contractual terms Monitoring costs develop ex-post for activities which serve to

control contractual obligations Conflict and enforcement costs arise ex-post due to

the different interpretation of the contract and the costs of enforcing contractual

regulations with sanctions negotiations or through court proceedings Adaption

costs are incurred due to ex-post changes in contractual agreements that become

necessary because of unpredictable developments24

TCE assumes the existence of bounded rationality and opportunism Bounded

rationality describes the limitation in human processing of information and the

planning of possible outcomes Opportunism describes the notion that humans may

act in a self-interested manner by manipulating information and being dishonest

The consequences of these assumptions are incomplete contracts and moral

hazards25 Vice versa opportunism occurs because firms can not write complete

contracts

The size of the transaction costs is determined in each case by the characteristics of

asset specificity uncertainty and frequency Asset specificity arises when the actor

in the market undertakes specific investments in order to fulfill his contractual 23 Chen and Mujtaba (2007) p322 24 Kieser and Ebers (2006) p278 25 Magill and Quenzii (1996) p11

8

obligations It refers to the degree to which long-lasting human or physical assets

are bound in a specific relationship and thus to the extent to which they provide

value in the context of a different situation26 In TCE markets can hardly solve the

problems that high uncertainty creates in combination with bounded rationality and

threats of opportunism Uncertainty includes environmental and behavioral

uncertainty Environmental uncertainty refers to political legal cultural and

economic uncertainties that may affect the success of business transactions

Behavioral uncertainty states that bounded rationality and the threat of opportunism

result in the high costs of monitoring a partner company27 If the similar

transactions are repeated frequently learning effects and economies of scale occur

and will reduce the transaction costs

32 Eclectic Theory

The eclectic theory28 (or OLI paradigm) was developed by John Dunning and is a

framework that merges different economic theories which explain foreign market

entry patterns of multinational corporations29 It states that the internationalization

of MNCs is determined by three sets of independent variables ownership

advantages (or firm- specific advantages) location advantages (or country specific

advantages) and internationalization advantages

The ownership advantage considers the competitive advantages of MNCs arising

from firm-specific characteristics such as size monopoly power economies of

scale management brand name technology and other resource capabilities30

These advantages are usually intangible assets and can be transferred at low costs31

The greater the competitive advantage of the MNC is the more likely it is able to

start or to increase its foreign production32

The location advantages arise from country specific benefits that can be divided

into three categories Firstly a host country may have economic advantages

comprising qualitative and quantitative factors such as production transports costs

26 Dietrich (1994) p18 27 Brouthers and Brouthers (2003) p1183 - 1185 28 Dunning (1980) Dunning (1988) Hill Kwang and Kim (1990) 29 Dunning (2002) 30 Forsbaeck and Oxelheim (2004) 31 Griffin and Pustay (2006) 32 Dunning (2002)

9

communication costs market size or tax incentives Secondly a host country may

offer political advantages in particular governmental policies that may influence

market entry Thirdly a host country may provide social and cultural advantages

including the psychic distance between the foreign and the domestic country as

well as language or cultural aspects that may have an impact on the market entry

decision The higher the attractions of the specific location the more likely it is that

MNCs will exploit their ownership advantage by entering the foreign market33

Because of the existence of transactions costs the internationalization incentive

advantage states that it must be profitable for the MNC to exploit these advantages

itself rather than through local companies (eg licensing)34

In economic literature the OLI paradigm has also been applied to the banking

sector In this regard ownership advantage may include easy access to a vehicle

currency Locational advantages may include country-specific regulations and

entry barriers Internationalization advantages can be information advantages and

access to local deposit bases35

Many empirical studies on the banking market have utilized the eclectic paradigm

as a basic framework For example a study of bank entry into CEE markets

concludes that the ownership advantages of foreign MNBs are strong compared to

banks in emerging markets and especially when the foreign country experiences a

banking crisis36 An application of the OLI paradigm to the Spanish banking

market has shown that bank size and multinational experience of MNBs favor

stronger commitment in the foreign country whereas distance is an entry barrier37

However theoretical literature also states that in service industries clients close to

the MNBs headquarters may be served from this location whereas clients in distant

markets require a physical presence of the MNB in the foreign country which

favors a foreign market entry with increasing distance38

33 Dunning (2002) 34 Hagen (1997) 35 Yannopoulus (1983) 36 Uiboupin and Sorg (2006) 37 Blandoacuten (1998) 38 Blondoacuten (1998) Terpstra and Yu (1988)

10

33 Strategy of Defensive Expansion

A common approach employed to explain the expansion of MNBs involves the

theory of defensive expansion which is also referred to as the acutefollow-the-

customeracute argument

This theory states that MNBs expand abroad in order to provide services for

domestic clients which are often large enterprises that have entered a foreign

market39 The provision of financial services in the foreign country usually requires

a presence at important economic centres Hence to some degree expanding

corporations impose pressure on their domestic banks to follow-up40

The term acutedefensiveacute is derived from the idea that a failure to expand may lead to a

loss of the client not only in the foreign country but also in the domestic one as

the client may associate with a foreign MNB41 Consequently MNBs which pursue

this strategy seek to prevent losses rather then to generate new profits in the foreign

market42 Furthermore the domestic bank has an incomparable competitive

advantage over banks in the foreign country with regard to the knowledge of

customer needs the respective risk of credit default as well as an interest in cross-

selling products such as financial advisory43

Due to earlier business relationships with the client the domestic bank has reduced

costs for examining the financial capacities of the respective enterprise and thus

can offer cheaper services44 Most foreign entry evidence supports the defensive

expansion theory45

A study on this theory with respect to retail banking has revealed that MNBs

sometimes expand abroad in order to provide banking services to specific

communities46

39 Trend im retail-banking koumlhler 40 Henneberger and Graf (2000) 41 Mullineux and Murinde (2003) 42 Naaborg (2007) 43 Knoop (2006) 44 Bhattacharya (1994) 45 Bhattacharya (1994) Naaborg (2007) 46 Tschoegl (1987)

11

34 Strategy of Offensive Expansion

MNBs that offensively expand abroad primarily seek to increase their customer

base both in the home and in the foreign country Firstly the establishment of

foreign branches and subsidiaries enables the MNB to expand their services to

domestic residents who benefit from the international orientation of the bank

These may include customers that have business partners in the foreign country

Secondly MNBs may target new customers in the foreign country in particular

MNEs or foreign subsidiaries of domestic enterprises As the MNB must in both

cases entice customers away from other banks the MNB has to offer attractive and

competitive conditions for their financial services47

47 Buumlschgen (1998) p604

12

4 Industry Analysis German Retail Banking Sector

41 Porter`s Five Forces

In the school of Industrial Economics the five-forces model has established itself

as a core element of industry analysis Porter`s analysis framework is built on the

following five market forces that shape the strategy of competitors threat of new

entrants threat of substitute products or services bargaining power of buyers and

suppliers as well as rivalry among existing competitors

Porterrsquos concept is based on the knowledge that the strategy of an enterprise must

orient itself to its market environment whereby the competitive strategy arises

from a differentiated understanding of the market structure and the knowledge of

how it changes The effects of these forces determine the intensity of the

competition in a market and with it its profitability and attractiveness Therefore

the aim of the enterprise strategy should be reflected in the search for possibilities

for the reduction or use of these competitive forces relative to its own enterprise In

this regard Porter`s model is conducive to the analysis of the driving forces

working in the respective industry

Figure 2 Michael E Porter`s five forces model (Own illustration based on Porter 1979)

Industry Rivalry

Threat of New

Entrants

Bargaining Power of

Buyers

Threat of Substitute Products

and Services

Bargaining Power of Suppliers

13

Porter`s framework is a useful and frequently utilized analytical tool to describe the

foundations of industry competition

A high degree of rivalry among the existing enterprises leads to high competitive

pressure and can lower profit margins and the profitability of individual

enterprises In situations in which a large number of enterprises target similar

market segments with comparable strategies in which the market grows slowly

price is the most important differentiation factor and high exit barriers exist a

negative impact on the industryrsquos profitability is effected48

The threat of new entrants can be determined by the entry barriers of a market The

competitive pressure on existing enterprises increases with low entry barriers In

such a situation important elements of the market (eg shares of the market price

level) can change due to the entry of new market participants49

The bargaining power of buyers determines to what extent customers can influence

enterprises by the amount of consumption and the pressure on margins Important

indexes of a high degree of buyer power include high fixed costs in the industry

existence of supplements of the product or service high degree of customer

concentration customers` knowledge of production costs possibility of a reverse

integration of customers high growth rates of the market and a strong

individualization of customer demand50

The bargaining power of suppliers affects industry profitability if for example a

concentrated supplier group dominates over existing enterprises in the market

which are not important buyers for the suppliers Then the industry faces high

margin pressure by the suppliers

A threat of substitute products and services exists in particular if cheaper or higher-

quality products and services are able to reduce existing sales volumes of a market

or an enterprise51 The future sales potential of existing enterprises becomes limited

and industry competition increases

48 Porter (1985) 49 Porter (1979) Recklies (2001) 50 Recklies (2001) 51 Recklies (2001)

14

Critics of this model state that it neglects the impact of complements as a sixth

force of the industry since they may facilitate or hinder the commercialization of

certain goods However Porter argues that complements are not a force itself but

they affect profitability in the way that they influence the five forces and that `the

strategist must trace the positive or negative influence of complements on all five

forces to ascertain their impact on profitability`52

One limitation of this model is based on studies which indicate that company-

specific factors may have a more important impact on profit than industry forces53

Furthermore the model suggests relatively static and stable market structure which

makes it difficult to assess contemporary dynamic markets54

The model does not assess the impact of the parent company on its subsidiary

which is especially important in the banking sector in which parent companies

often have a strong impact on the performance of their subsidiary or branch The

parenting advantage includes the stand-alone influence through monitoring and

influence on management decisions or capital expenses Furthermore parents

create value by enhancing synergies within the group offering corporate functions

or managing portfolios55

42 Rivalry among existing competitors

In this section the intensity of competitive rivalry among existing competitors in

the German retail banking sector is discussed In this regard an analysis of industry

structure industry growth and exit barriers will be conducted

Industry structure The German banking market is characterized by a three-pillar

system which is reflected by the strict distinction between public-law banks

cooperative banks and private banks56 Each pursues different goals and is subject

to different regulations Private commercial banks pursue the goal of profit

maximization whereas saving banks serve the public contract of offering secure

52 Porter (1997)p11 53 Zack (1999) 54 Recklies (2001) 55 Goold Cambpell and Alexander (1994) 56 Gramlich (2005)

saving possibilities and loans C

interest of their members

banking market is structured as follow

Figure 3(own illustration based on Sch

Public-law banks including saving banks and state banks

total balance sheet volume of banks in Germany

do not participate in retail banking The cooperative bank sector amounts to 11

the total including cooperative banks

cooperative central banks

commercial banks including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

31 of total balance sheet volume

European Research (ZWE) 43 of experts state that the three

important or very important and

for the low number of cross

In order to describe industry rivalry among maj

retail sector the following table illustrates the number of customers per bank in

Germany

57 Engerer (2006) 58 Koumlhler (2008b)

banks 24

Private commercial banks 31

15

possibilities and loans Cooperative banks primarily serve the economic

interest of their members57 In terms of total balance sheet volume the German

banking market is structured as follows

Figure 3 Structure of the German Banking Sector(own illustration based on Schrooten 2009)

law banks including saving banks and state banks amount to 33 of the

total balance sheet volume of banks in Germany However state banks

do not participate in retail banking The cooperative bank sector amounts to 11

including cooperative banks which participate in retail ban

cooperative central banks which primarily serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

alance sheet volume According to a recent survey of the Center for

European Research (ZWE) 43 of experts state that the three-pillar system is

important or very important and 33 state that it is the critical factor responsible

cross-border mergers and acquisitions in Germany

In order to describe industry rivalry among major banks that participate in the

the following table illustrates the number of customers per bank in

Savings banks 13

State banks 20

Cooperative central banks

3Credit cooperative banks 8

Other banks 24

serve the economic

sheet volume the German

Structure of the German Banking Sector

amount to 33 of the

However state banks generally

do not participate in retail banking The cooperative bank sector amounts to 11 of

participate in retail banking and

serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks amount to

According to a recent survey of the Center for

pillar system is

33 state that it is the critical factor responsible

border mergers and acquisitions in Germany58

or banks that participate in the

the following table illustrates the number of customers per bank in

State banks 20

Cooperative central banks

16

Figure 4 Customers of German Banks at the end of 2007 in millions (own illustration based on Deutsche Bank 2008)

With approximately 50 million customers savings banks are the market leader in

the German retail banking sector Although state liability assumption for savings

banks was abolished in 2005 because the EU saw in it an unacceptable subsidy to

the disadvantage of private banks customers still associate the name `Sparkasse`

with state guarantees The specific characteristic of a saving bank is based on its

public contract in that it has to accept customers with poor credit-worthiness that

profits should be used to enhance public wealth and that the middle class should be

supplied with loans59

With approximately 30 million customers cooperative banks are the second major

player in the German retail banking sector Nearly half of these customers are

members of the cooperative banks60 In contrast to the profit maximization goal of

private commercial banks their aim is to fund their members and secure their

economic independence Although cooperative banks are economically and legally

independent in the different regions they appear uniformly as a group under the

brand of ldquoVolks- und Raiffeisenbankenrdquo With regard to growth in customer base

cooperative banks benefit from the advantage of having the regional flexibility that

59 Kruck (2008) 60 Online Raiffeisen Bank Homepage

31

4

61

118

242

30

50

0 10 20 30 40 50 60

Citibank

Hypovereinsbank

ING DiBa

Commerzbank and Dresdner Bank

Postbank and Deutsche Bank

Credit Unions (Volksbanken)

Savings Banks (Sparkassen)

17

allows for topical advertisement as well as a centralized management focus on

improving reputation61

The third group comprises the major private commercial banks including Deutsche

Bank Postbank Commerzbank and Hypovereinsbank Deutsche Bank is a leading

multinational investment bank but with relatively low market share in the retail

banking market Deutsche Bank (97 million clients) is acquiring Postbank (145

million clients) with its broad branch network in a three-step process Together

they have 242 million clients However Heino Ruland from the analyst company

Frankfurt Finanz Partner argues that Deutsche Bank might not be able to capitalize

on the financially weaker Postbank clients as Deutsche Bank is specialized in

corporate clients62 With regard to rivalry intensity and market profitability Rainer

Neske supervisory board member and head of private amp business clients of

Deutsche Bank emphasizes that the German retail banking market is too

fragmented to be highly profitable and that Deutsche Bank does not seek to

compete on the price level but defines itself through performance quality and

consultancy63

Commerzbank is the second largest private commercial bank in Germany After the

acquisition of Dresdner Bank in 2009 Commerzbank now serves more than 12

million clients (of these 11 million private and one million corporate clients) and

pursues the goal of becoming the market leader in Germany64

UniCredit Bank AG with the brand name Hypovereinsbank (HVB) is a subsidiary

of UniCredirSpA and is the third largest private commercial bank in Germany

HVB serves approximately four million clients predominantly in north Germany

and in Bavaria As its retail banking segment could only report marginal profits in

2009 speculation about a sale or acquisition in this segment has come up As the

Swedish SEB (Skandinaviska Enskilda Bank) is considering selling its German

retail segment with 174 branches and one million clients experts now regard HVB

as a major buying candidate65

61 Schwarzbauer (2009) 62 Kreiler (2008) 63 Deutsche Bank (2009) 64 Kreiler (2008) 65 Houmlpner and Nagl (2010)

18

ING DiBa AG is a subsidiary of the Dutch ING Group and serves over 6 million

clients In contrast to savings cooperative and the major private commercial

banks ING DiBa is specialized in direct banking which distributes services via

telephone the internet or post instead of through branches In Germany ING

DiBa is the leader in direct banking but there are many other direct banks such

as Comdirect (a subsidiary of Commerzbank) Volkswagen Bank or DAB Bank

(a subsidiary of HVB) Competition takes place not only among direct banks but

also between direct and branch banks For instance many saving banks have

blocked the opportunity for customers of direct banks to withdraw cash from their

automated teller machines As savings banks can only charge Euro 174 for

withdrawals via visa cards they fear that direct banks can gain market share by

offering attractive account options with a convenient wide-area ATM provision66

Targobank (former Citibank Deutschland) was acquired by the French

cooperative bank Creacutedit Mutel and now serves more than 34 million clients in

Germany in 2010 The bank is specialized in private retail customers with

branches and direct banking67

In conclusion the degree of concentration in the German retail banking market is

very low which reduces the overall profitability of this sector for two main

reasons Banks earn higher profits in concentrated markets as they obtain either

monopoly rents (structure-conduct-performance paradigm) or due to high market

shares that are gained by more efficient and profitable banks (efficient structure

hypothesis)68 As retail banking services are largely standardized product

differentiation is low and price differentiation is often the only option As public-

law banks serve other interests than profit maximization existing private banks

and MNBs that want to enter this market have a competitive disadvantage The

low switching costs of clients intensifies competition on the price level and thus

reduces the profitability of the market However brand identification and

customer relationships are also important which decreases the willingness of

clients to switch solely on the basis of price comparison In summary market

structure indicates a very high degree of rivalry among existing competitors

66 Online Financial Times Deutschland (2010) 67 Targobank (2010) 68 Havrylchyk and Jurzyk (2006) p15

19

Industry growth In this section industry growth will be examined in a dynamic

analysis of three relevant market growth indicators the future long-run

development of the German population the historical development of the number

of banks and branches in Germany and the historical development of market-

share allocation in the context of major retail banking activities

In the long-run market growth depends on the future numerical development of

the market`s customers - the German population As the growth of population

through birth and immigration is smaller than its decrease by virtue of the mortality

rate and emigration the Federal Statistical Office in Germany estimates a sharp

decline of the German population

Figure 5 Estimated Development of German Population (in millions)

(Federal Statistical Office 2009)

The Federal Statistical Office predicts that the trend of decline in population since

2003 will continue and intensify Whereas approximately 82 million people lived

in Germany in 2008 only between 65 million (average lower limit of the

population with 100000 immigrants yearly) and 70 million people (average

upper limit of the population with 200000 immigrants yearly) will reside in

Germany in 2060 Furthermore the decreasing number of births and the ageing of

the current strongly represented middle age group will lead to substantial changes

in the age structure of the population From 2008 to 2060 the proportion of people

from 65 to 80 years will increase 15 to 20 and the proportion of people over

80 years of age will increase from 5 to 14 of the population69 The

69 Federal Statistical Office (2009)

Average lower limit

Average upper limit

20

implications of the aging population for banks will be discussed in the comparison

between direct banks and BampM banks in section 66 of this thesis

The second indicator of industry growth deals with the number of banks and bank

branches in the German market The overall number of banks in Germany

decreased from 3785 in 1995 to 2300 in 2006 As retail banking usually depends

on the number branches maintained their development in Germany will be

examined

Figure 6 Development of Total Bank Branches in Germany (own illustration based on Koumlhler2008a)

Savings banks and cooperative banks have reduced the number of branches

significantly Public-sector banks (savings banks state banks etc) with 18757

branches and cooperative banks with 16028 branches in 1998 reduced the

number of branches to 14252 and 12303 respectively in 2006 Moreover the

number of branches of major commercial banks decreased from 19055 in 1998 to

8879 in 2006

The main cause for the decrease of branches is the high fixed costs which can not

be recouped from low-revenue standard products that can also be distributed

through alternative low-cost channels such as the internet70

70 Koumlhler and Land (2008)

67930 6666363186

59929 58546 5693653931

5086847244 45467 44100

40332

0

10000

20000

30000

40000

50000

60000

70000

80000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

21

As a third indicator of industry growth this paper reflects on the allocation of

market share within the retail banking sector in order to indentify trends that may

affect overall market growth This paper will reflect on market share in two major

retail banking segments - savings deposits and loans The German Central Bank

classifies the banking market in terms of savings banks cooperative banks direct

banks and credit banks The latter include universal banks which are private

commercial banks branches of foreign banks regional banks and other private

banks

This section reflects the development of market share regarding short- medium-

and long-term saving accounts and examines the allocation of loans to corporate

clients consumers (consumer loans) private households and self-employed

persons

In the period from 1998 to 2006 the market for medium-term saving deposits with

a cancellation period under three months has been dominated by saving banks (53

market share in 2006) and cooperative banks (29 market share in 2006) In the

same period the market share for long-term saving deposits with a cancellation

period above three months has also continuously been dominated by savings banks

(65 market share in 2006) and cooperative banks (24 market share in 2006)

However with regard to deposits that mature daily direct banks were able to

increase market share from approximately 15 in 1998 to over 15 in 2006

Figure 7 Market share development of saving accounts that mature daily (own illustration based on Deutsche Bundesbank 2007)

000

500

1000

1500

2000

2500

3000

3500

4000

4500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Banks

Cooperative Banks

Savings Banks

Credit Banks

22

From 1998 to 2006 market share for loans for corporate clients has been

continuously dominated by credit banks (53 market share in 2006) and savings

banks (34 market share in 2006) However this data also comprises loans for

medium and large corporations which are not part of the retail banking market

Loans for private households and self-employed persons have predominately been

granted by savings banks (39 market share in 2006) credit banks (30 market

share in 2006) and cooperative banks (25 market share in 2006) though direct

banks were able to gain some market share from 0 in 1998 up to 5 in 2006

Even more significantly direct banks were able to gain over 16 market share in

the segment of consumer loans

Figure 8 Market share development of consumer loans (own illustration based on Deutsche Bundesbank 2007)

Hence the most significant growth indicator of the retail banking market results

from the emergence of direct banks which were able to gain substantial market

share in consumper loans and deposits that mature daily

In conclusion the industry growth analysis indentifies the following growth

indicators Firstly a sharp decrease in the German population in the following

decades will reduce growth and increase industry rivalry Moreover the

demographic change increases the proportion of old people in the population

Secondly the number of branches in Germany is decreasing due to high fixed

costs of branches In order to be profitable in retail banking the existing branches

must serve a large quantity of customers which leads to strong competition

relative to market share Thirdly the development of market share allocation

000

1000

2000

3000

4000

5000

6000

7000

2002 2003 2004 2005 2006

Savings Banks

Cooperative Banks

Direct Banks

Credit Banks

23

indicates that only direct banks have experienced significant growth from 1995 to

2006

Exit barriers From a perspective of Transaction Costs Economics one can argue

that exit barriers in branch banking are high for market participants as branches

and staff are highly specific assets that lose value when used in another situation

To a large extent these assets are locked into the context of retail banking

Moreover public-law banks usually have to serve the population regardless of

whether they are profitable or not In a situation in which a bank continuously

experiences losses staff and branches may be considered as sunk costs and thus

economically `irrationalacute exit barriers However theories suggest that staff and

branches are practically valid exit barriers and cause MNCs to stay in a market71

The high degree of exit barriers intensifies the strong rivalry among existing

competitors

43 Threat of New Entrants

New entrants usually seek to gain market share while applying pressure on prices

and costs and thus increasing the investments necessary to compete An expert

survey conducted by the ZEW emphasizes the importance of entry threat to the

German retail-banking market 6666 of market experts state that new

competitors (eg foreign banks) have an important or a very important impact on

industry rivalry72

In this section the threat of new entrants to existing market participants in the

German retail banking sector is discussed In this regard this section evaluates

legal entry barriers capital requirements the necessity of large scale operations

customer switching costs and incumbency advantages of existing domestic banks

Legal entry barriers are determined by governmental regulations in the German

Banking Act (GBA) and are supervised by the Federal Supervisory Authority73

According to section 32 para 1 (1) GBA companies that intend to pursue

commercial banking transactions or financial services in Germany require written

71 Hill Hwang and Kim (1990) 72 Koumlhler and Lang (2008) 73 Bundesanstalt fuumlr Finanzdienstleistungsaufsicht (2005)

24

permission from the Federal Financial Supervisory Authority ( ldquoBundesanstalt fuumlr

Finanzdienstleistungaufsichtrdquo) The execution of banking transactions or financial

services also exists when the operator has its headquarters or primary residence

abroad but repeatedly targets companies or individuals who have their primary

residence in Germany In order to obtain the permit several requirements are

examined (eg business plan qualified management etc)

Companies from third countries which intend to conduct banking transactions and

provide financial services in Germany must establish a subsidiary (section 32 para

1 in connection with ection 33 para 1 (6) GBA) or a branch (section 32 para 1 in

connection with section 53 GBA) in Germany Companies from third countries can

apply for an exemption according to section 2 para 4 GBA if the company is

supervised utilizing international accounting standards in the home country and the

responsible authority works together with the BaFin According to section 53b

GBA companies of EEA states are allowed to establish branches (section 53b para

2) but are also free to conduct cross-border financial services without a domestic

presence (section 53b para 2a) Section 32 para 1 GBA does not apply to business

that is motivated by the initiative of the domestic individual or enterprise (so called

passive service freedom)

Representations are limited to their representative function and are not allowed to

conduct or initiate any banking business

Capital requirements are low for cross-border lending and and relatively low for

representations With high equity modes such as branches and even more so with

subsidiaries capital requirements are relatively high as capital is required for

building a broad network of facilities and offering credit to customers Capital

requirements for direct banks are relatively low compared with those of BampM

banks

The necessity of large scale operation is related to the competitive advantage of

economies of scale A company that serves the market in the context of larger

quantities benefits from lower cost per unit In retail banking profit is gained by

having a large number of clients It is expensive to build up these numbers and to

establish a distribution network to serve them This necessity relates directly to the

strategy of the bank An acquisition offers a shortcut to these facilities although the

25

costs of integration can be high as well74 A MNB may also decide to target only a

certain geographical area with certain clients and therefore do not have to enter on

a very large scale

Customer switching costs are different for each individual In general customers

can easily change their banks and open a deposit account or apply for a loan at

another bank However they have to compare the different terms for usually small

transactions to evaluate the convenience of having a bank nearby and then to

decide to terminate the relationships with their current bank75

Finally the incumbency advantages of existing banks are important entry barriers

In particular they include established brand reputation possession of the most

favorable geographical locations and market knowledge Moreover established

banks may already have exclusive contracts with SMEs76

To conclude legal entry barriers are low and particularly low for banks from the

EEA Capital requirements for entering the market are high yet as far as equity

entry modes are concerned direct banks require relatively low capital as they

distribute their services through low-cost channels Banks need to attract many

customers to be profitable but banks strategy dictates whether or not to entrance

should occur on a large scale Moreover the incumbency advantages of existing

banks constitute important entry barriers

44 Threat of Substitute Products or Services

A substitute in retail banking is a service that offers an attractive trade-off to a bank

service or product As individuals and small firms do not regularly report financial

information as do large enterprises they rely primarily on bank lending However

there are additional forms of financing in the private equity or dept market77

Many non- and near- banks provide substitute products and services Near-banks or

quasi-banks are suppliers of financial services but are not classified as credit

institutes according to section 1 GBA Near-banks such as insurance companies or

credit card organizations however do provide substitute products or services Non-

74 Hughes and MacDonald (2009) 75 Adams (2002) 76 Adams (2002) 77 Xiaoqin and Terada-Hagiwara (2003)

26

banks such as department store chains catalog companies or car producers also

provide substitute services78 For instance instead of taking out a loan in order to

pay for a product individuals or small enterprises may decide to take on a leasing

contract for a certain asset or small enterprises can obtain a trade credit as well

Individuals may decide on buying products from insurance companies instead of

putting money into a bank account

Another substitute for both direct and BampM banks is the person-to-person (p2p)

lending business a new form of borrowing and lending money that takes place in a

web-based market place In this online platform borrowers are connected to

lenders through an auction-like process in which a lender who bids to provide a

loan for the lowest interest rate will be awarded the loan contract with the

borrower A p2p company mediates between private or company borrowers and

lenders and also executes transactions between the parties similar to the role which

e-bay plays in the trade of commercial goods79 The p2p lending business does not

involve traditional banks and thus can offer superior interest rates to borrowers and

higher returns for lenders

45 Bargaining Power of Suppliers

When a supplier group is more concentrated than the industry does not primarily

depend on the industry and when the industry faces high switching costs the

supplier group has strong bargaining power and can reduce the profit potential of

an industry In the retail banking market the most relevant suppliers include human

resources suppliers of capital resources and suppliers of information and

communication technology (ICT)80 Highly talented or experienced specialists are

strongly canvassed and have strong bargaining power with respect to their salary

and working conditions However in the aftermath of the financial crisis many

banks are planning a reduction of staff According to a study of Ernst amp Young

every fifth bank intends to decrease staff and only every 10th bank is planning an

increase81 Given the current situation of the employment market the bargaining

power of employees is relatively low Suppliers of highly specialized banking ICT

78 Gabler Wirtschaftslexikon (2010) 79 Deloitte (2009) p 12 80 Buumlschgen and Boumlrner (2003) 81 Ernst amp Young (2009)

27

solutions have strong bargaining power as switching costs for these systems are

very high Moreover the higher yield requirements of shareholders can be

interpreted as supplier power

46 Bargaining Power of Buyers

In retail banking there are many buyers with relatively low transaction volumes

which weakens their bargaining power However retail banking services are

standardized and buyers can easily find similar services Switching costs have

usually been relatively high for these low volume transactions but in the age of the

internet the market is very transparent and buyers can screen different offerings

more easily This does not necessarily imply that the cheapest banking service will

be chosen automatically as customers also seek a trustworthy brand especially in

times of financial crisis Moreover there are other factors that affect the switching

cost of the individual such as the location of the branch Yet there is a tendency

towards the increasing bargaining power of buyers

This is also substantiated by the ZEW survey 7984 of market experts state that

decreasing customer loyalty and increasing price sensibility are important or very

important factors with respect to the intensity of competition in the German retail

banking sector A comparison of former and modern retail customers also indicates

that the bargaining power of retail banking service users has increased

Former Retail Customer Modern Retail Customer

Passive information seeking

behavior

Active information seeking behavior

Hardy or little informed Good to very good know-how

High customer loyality Increasing willingness to switch

Fixation on the branch Expects multi-channel banking at all times

and places

Little market transparency High price transparency

Relatively undemanding Demanding

Figure 9 Comparison of former and modern retail customers (own illustration based on Swoboda 2004)

28

5 Foreign Bank Entry Strategies in Germany

This section illustrates mode choices for foreign bank entry in Germany Based on

the hierarchical model of market entry modes82 the foreign bank has the choice of

equity and non ndash equity modes of entry An advantage of the hierarchical model is

that it allows comparing between entry modes on different levels The main

difference between equity and non ndash equity modes is the degree of resource

commitment in the foreign country As classified at the beginning of this thesis

non-equity entry refers to international banking and equity entry refers to

multinational banking

The research question of this thesis considers multinational bank entry modes

International banking however is often a first step towards multinational banking

Hence this thesis will also discuss cross-border lending and alliances as non ndash

equity entry modes The following figure illustrates a comprehensive view of

market entry modes for banks

Figure 10 A hierarchical model of entry mode choices for banks (own illustration based on Pan and Tse 2000)

82 Pan and Tse (2000)

Entry Mode Choices

Non - Equity Modes

Export

Cross Border Lending

Contractual Agreements

Alliances

Equity Modes

Equity Joint Ventures

Greenfield Investment

Branch

Subsidiary

Representation

Acquisition

Subsidiary

Branch

29

The hierarchical model illustrates the various entry mode choices for entering the

German retail banking market The creation of a common European financial

market in which banks can integrate freely is a major goal of the European Union83

The previous section of this paper indicates that entry barriers are relatively low

and that the German market is highly competitive Hence the choice of a proper

entry mode which is appropriate to the capabilities and the strategy of the bank is

even more significant Therefore the following section will reflect on the strategic

concept governing the choice of entry modes as well as the proliferation of these

entry modes in the German retail banking market

An international bank that is not interested in investing equity in the foreign

market can enter by means of cross-border lending or by forming a non-equity

alliance These non-equity entry modes can help the bank to access niche markets

or to exploit locational advantages when the bank is located near the German

border

However a retail bank defined in the beginning of this paper as a bank that

`caters for ordinary individuals and small businessacute and that seeks to enter the

German market in order to gain significant revenue from deposits and loan

business might have to consider a physical presence in the foreign country

The analysis considers entry modes that are perceived as international banking

cross-border lending and non-equity strategic alliances Furthermore the equity

modes JVs and representations will be discussed

Subsequently this section compares the market entry of a branch through

Greenfield investment with the market entry of a subsidiary by virtue of

acquisition as these modes of entry are the most common in the German retail

banking market

Finally the following question will be addressed to what extent do demographic

and technical trends favor a direct bank entry mode over a brick and mortar bank

approach in Germany

83 Fidrmuc and Hainz (2008)

30

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks (own illustration)

51 Non ndash equity modes Export ndash Cross-Border Lending

Cross-border lending is equivalent to the export entry mode and is a simple non-

equity strategy to enter a foreign market A bank which participates in cross-

border lending must assess the creditworthiness of the individual borrower as well

as the country risk which involves the possibility that these loans will be impaired

by economic or political proceedings in the foreign country84 The country risk in

Germany is rather low as it is perceived to have a solid political and economic

situation (Country Rating A2) with a stable and a very efficient business

environment (Country Rating A1)85 As a bank will only have limited access to soft

information about the creditworthiness of the borrower the availability of loans

usually decreases and the interest on loans usually increases with distance86 Soft

information for private loans includes the previous experience with the account

management of the credit user environmental facts and a judgment relative to his

employment contract87 For corporate loans soft facts may include the market

environment corporate structure management a business plan as well as

84 Hughes and McDonald (2003) 85 Online wwwtrade-safelycom (2009) 86 Agrawal and Hauswald (2007) 87 Dizil (2009)

Entry Mode Choices of MNBs

Greenfield Investment

Branch

Brick and Mortar Bank Direct Bank

Acquisition

Subsidiary

Brick and Mortar Bank Direct Bank

VII

53 Joint Ventures 32

54 Representations 33

55 Entry Mode Choice Greenfield-Branch vs Acquisition-Subsidiary 34

56 Business Model Choice Direct Bank vs Brick and Mortar Bank 38

561 Demographical Trends 40

562 Technological Trends 42

6 Case Study ING DiBa 45

61 Corporate Profile ING Group 45

62 Market Entry and Market Penetration 45

63 SWOT Analysis 46

64 ING DiBa SWOT Analysis 48

641 Strengths 48

642 Weaknesses 48

643 Opportunities 49

644 Threats 49

65 The Service Marketing Mix 50

66 ING DiBa Marketing Mix (7Ps) 52

67 Summary 55

7 Conclusion 56

Literature

Appendix

VIII

List of Figures

Figure 1 Classification of retail banking clients 6

Figure 2 Michael E Porter`s Five Forces model 12

Figure 3 Structure of the German banking sector 15

Figure 4 Customers of German banks at the end of 2007 (in millions) 16

Figure 5 Estimated development of the German population (in millions) 19

Figure 6 Development of total bank branches in Germany 20

Figure 7 Market share development of accounts that mature daily 21

Figure 8 Market share development of consumer loans 22

Figure 9 Comparison of former and modern retail banking customers 27

Figure 10 A hierarchical model of entry mode choices for banks 28

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks 30

Figure 12 Development of foreign MNBs branches in Germany 35

Figure 13 Development of foreign MNBs subsidiaries in Germany 37

Figure 14 SWOT analysis 47

Figure 15 Service Marketing Mix 51

IX

List of abbreviations

ATM Automated Teller Machine

BampM Brick and Mortar

CEE Central and Easter European

EEA European Economic Area

FDI Foreign Direct Investment

GBA German Banking Act

ICT Information and Communication Technology

JV Joint Venture

MNB Multinational Bank

MNE Multinational Enterprise

RDC Remote Deposit Capture

SMEs Small and Medium Sized Enterprises

TCE Transaction Costs Economics

WOS Wholly Owned Subsidiary

ZEW Centre for European Economic Research

1 Introduction

In the aftermath of the recent financial crisis1 and in times in which banks

rediscover the private individual ndash also described as the renaissance of retail

banking2 - significant attention is now being paid to the market entries of foreign

multinational banks3

The German retail banking market is highly competitive Private cooperative and

state-controlled savings banks compete intensely for market share with hardly any

cooperative activities among the groups As savings banks are owned by German

states towns or local authorities they are protected by law from takeovers by

institutes from the other banking sectors4 Due to the high fragmentation of the

German market hardly any bank has dominant market power The five largest

banks have a total market share of only 20 percent and new competitors enter the

market and attract customers with aggressive price differentiation offers5 The

strong competition among private banks savings banks and co-operative banks

results in low profit margins by international comparison The profit potential in

German private-customer business has fallen for many years From 2000 to 2006

total income from the financial service providers in Germany measured by the

distribution of financial products with private customers fell approximately 15

from euro 675 billion to euro 574 billion6 Though the retail banking sector has

experienced some increase in profits due to cost reduction and reduced loan

failures in 2007 market potential still stagnated in 20097

Since the financial crisis has raised the awareness of the threats of investment

banking many banks have refocused on core business activities in order to

maintain their solvency through increased account deposits Banks need money to

grant loans to private individuals or enterprises provide investment opportunities

finance consumer goods or simply realize baking transactions Yet the recent

financial crisis caused distrust among the banks and loans will not be granted as

1 Plickert (2009) 2 Deutsche Bank (2009) 3 Koumlhler and Lang (2008) 4 Spiegel Online (2007) 5 Welp (2009) 6 Zebrolfesschierenbeckaccosiates (2008) 7 McKinsey amp Company (2007) Zebrolfesschierenbeckaccosiates (2008)

2

easily as before On the consumer side the financial crisis has increased the

demand for secure money investments A survey of 230 highly ranked managers

from private savings and co-operative banks on the effects of the crisis on their

business indicates that banks have concentrated more intensively on business with

private customers both during and after the latest crisis Moreover customer

demand for certificates company shares or funds has fallen significantly while the

demand for standard retail banking products such as call money accounts or

account books has increased substantially8

In spite of its high competitiveness and low profit margins the German retail

banking market is still attractive for foreign banks Foreign MNBs are increasingly

able to penetrate the market for private individuals9 In particular they gain market

share through new products decreasing prices standardized processes and

innovative marketing whereas domestic banks have often relied on continued

customer loyalty10 Although foreign multinational banks in Germany have usually

concentrated on large domestic corporations engaged in international

transactions11 they now enter the market for private and small corporate clients as

well12- a trend that has been supported by the development of internet technology

and other new marketing - channel options

The distinctive characteristics of the German banking market raise several

questions concerning both entry mode and business model considerations of

multinational banks Should a multinational bank engage in cross-border lending or

rather enter the market via foreign direct investment How do the development of

economic political-legal and social-cultural factors in the German market affect a

multinational bank`s entry mode and business model choice

This thesis distinguishes between the non - equity entry modes of cross-border

lending and alliances as well as the equity entry modes of representative offices

branches subsidiaries and JVs both from a Greenfield investment and an

acquisition point of view Each of these organizational entry mode forms has

8 Welp (2009) 9 Reitz (2005) 10 McKinsey amp Company (2007) 11 Hersh and Weller (2002) 12 Koumlhler (2008)

3

distinctive advantages and disadvantages Hence the main focus of this thesis is to

provide a broad understanding of the distinctive market entry and penetration

strategies in light of macro and micro economical developments in Germany

11 Research Objective

This thesis examines entry mode choice decisions and business model

considerations of multinational banks entering the German retail banking sector

The objective is to evaluate the affect of current market developments on their

entry mode decisions

In light of the financial crisis and the banks` rediscovery of the private individual

the German banking sector is currently experiencing a renaissance resulting in

increasing industry rivalry At the same time the processing of bank transactions

and customer services is becoming increasingly independent of the branch

distribution channel and the adoption of new technologies is substantially affecting

the allocation of retail banking services13 The technological evolution is

exemplified by the emergence of web-based direct banks which have been able to

penetrate the retail banking market with low-cost structures innovative ideas and

distinctive service thinking

Eventually the growing importance of the internet and other technological means

as distribution channels on the one hand and the remaining strong demand for

personal consultation on the other hand require a customer-oriented multi-channel

management of the banks14

This paper contrasts the two opposing ends in the field of retail banking

distribution channels It simplifies the entry mode choice between direct banks that

solely operate through the internet and brick amp mortar banks which solely operate

through a branch network Furthermore it differentiates between branch entry via

Greenfield investment and subsidiary entry via acquisition

Two major questions will be addressed

13 Deloitte (2010) 14 Welp (2009)

4

Firstly to what extent do demographic and technical developments favor a direct

bank entry mode over a brick and mortar bank approach in Germany

Secondly what affects the decision in favor of a branch entry mode via Greenfield

investment as compared to a subsidiary entry mode via acquisition in Germany

12 Structure

This thesis is systematically divided into two different complexes - a theoretical

and a practical After a classification of essential banking terms in the section 2

Section 3 then describes relevant market entry theories ndash namely the Transaction

Costs Theory and the Eclectic Theory as well as market entry strategies ndash namely

the offensive and the defensive strategies of expansion

In section 4 the German retail banking market is analyzed within the five forces

framework The goal of this examination is to evaluate market attractiveness and to

identify micro and macroeconomic developments that may shape the market in the

future

Given the theoretical framework of section 3 and the knowledge of industry

structure and trends of section 4 section 5 explores the decision driving factors of

entry mode choice In this section cross-border lending alliances joint ventures

and representations will be discussed Furthermore this section indicates what

affects the decision in favor of a branch entry mode via Greenfield investment as

compared to a subsidiary entry mode via acquisition and to what extent

demographic and technical developments favors a direct bank entry mode over a

brick and mortar bank entry mode in Germany

Section 6 introduces the SWOT analysis as well as the Service Marketing Mix and

applies these concepts to the ING - DiBa case study It illustrates how ING- DiBa

penetrated the German retail banking market with both the implementation of the

direct banking business model and the exploitation of external opportunities

Finally this thesis concludes with a summary of the major findings

5

2 Classification of Banks

21 Bank

This paper refers to banks as defined in the German Banking Act Section 1 GBA

defines financial institutes as enterprises which pursue banking transactions

insofar as the extent of these transactions requires commercial business operations

At least one of the following transactions has to be carried out security

transactions credit transactions payments transactions or other banking business

The enterprise which pursues banking transactions in Germany requires the

permission of the BaFin (Federal Institution for Finance Service Supervision)

according to section 32 GBA

22 Direct Bank

Direct banks are credit institutes which operate without a branch network and

utilize the internet and the telephone as direct communication channels through

which banking transactions are realized and marketing and customer service takes

place Thus direct banks establish cost advantages which they usually transmit in

the form of attractive terms15

23 Brick and Mortar Bank

A brick and mortar (BampM) company is a traditional street-side business that

deals with its customers face to face in an office that the company owns or rents16

A brick and mortar bank serves consumers in a physical facility as distinct from

providing online or telephone services only The term brick and mortar is not a

generally valid classification of a bank but in the jargon of e-commerce it is

frequently employed to distinguish from internet based enterprises In this thesis

the term brick and mortar bank is employed to differentiate between a direct bank

that operates through direct channels and one which operates solely through its

branch network The term brick and mortar is also distinguished from the term

click and mortar which is an expression for a form of multi-channel retailing in

15 Deutsche Bundesbank (2010) 16 Investopedia Dictionary (2010)

6

which both electronic distribution channels (click) and physical premises (mortar)

are utilized17

24 Multinational Bank

Multinational banks are defined as banks that have a physical presence in more

than one country In contrast international banks engage in cross-border operations

but do not establish a physical presence in foreign countries18

25 Retail Bank

There is no generally valid classification of retail banking in theoretical literature

or in practice19 A distinction in retail banking is often made with regard to its

target clientele In this regard some authors define retail banking as the offering of

banking and financial services to individuals and small and medium sized

enterprises20 Other sources define retail banking as the provision of these services

solely to individuals21 This paper employs the following classification of retail

banks `A retail bank is a bank that caters for ordinary individuals and small

business as distinct from large corporations Retail banking operations offer

deposit facilities lend money transfer funds and are prepared to deal in relatively

small amounts`22 In contrast to private and corporate banking retail banking

considers private clients with low to average income as well as small corporate

clients

2

Figure 1 Classification of retail banking clients

(own illustration based on Swoboda 2004)

17 Gabler Wirtschaftslexikon (2010) 18 Hersh and Weller (2002) 19 Muumlller and Joumlhnk (2005) 20 Pond (2007) FinanceWiki (2008) Tremblay and Tremblay (2007) 21 Frei Harker and Hunter (1998) Online Businessdictionarycom (2010) Investoglossarycom (2010) 22 Essvale Corporation Limited (2007)

Retail Banking

Medium and large corporate clients

Wealthy private clients

Small Corporate clients

Private clients

7

3 Market Entry Theories and Strategies

31 Transaction Costs Theory

In the transaction cost theory developed by Ronald Coase and Oliver E

Williamson a comparison of transaction costs determines the optimal form of

organization In TC Theory the entry mode decision is a tradeoff between the

control and the costs of resource commitment Entry modes vary in three major

aspects the cost of resource commitment control as the level of ownership and

environmental risks that may affect the committed resources Hence high-control

modes increase both risk and the potential return23

Williamson differentiates between ex-ante and ex-post transaction costs

Information and searching costs are incurred ex-ante in the process of collecting

market information and identifying suitable partners Negotiation and contract

costs arise ex-ante due to negotiations legal advisory and the determination of

contractual terms Monitoring costs develop ex-post for activities which serve to

control contractual obligations Conflict and enforcement costs arise ex-post due to

the different interpretation of the contract and the costs of enforcing contractual

regulations with sanctions negotiations or through court proceedings Adaption

costs are incurred due to ex-post changes in contractual agreements that become

necessary because of unpredictable developments24

TCE assumes the existence of bounded rationality and opportunism Bounded

rationality describes the limitation in human processing of information and the

planning of possible outcomes Opportunism describes the notion that humans may

act in a self-interested manner by manipulating information and being dishonest

The consequences of these assumptions are incomplete contracts and moral

hazards25 Vice versa opportunism occurs because firms can not write complete

contracts

The size of the transaction costs is determined in each case by the characteristics of

asset specificity uncertainty and frequency Asset specificity arises when the actor

in the market undertakes specific investments in order to fulfill his contractual 23 Chen and Mujtaba (2007) p322 24 Kieser and Ebers (2006) p278 25 Magill and Quenzii (1996) p11

8

obligations It refers to the degree to which long-lasting human or physical assets

are bound in a specific relationship and thus to the extent to which they provide

value in the context of a different situation26 In TCE markets can hardly solve the

problems that high uncertainty creates in combination with bounded rationality and

threats of opportunism Uncertainty includes environmental and behavioral

uncertainty Environmental uncertainty refers to political legal cultural and

economic uncertainties that may affect the success of business transactions

Behavioral uncertainty states that bounded rationality and the threat of opportunism

result in the high costs of monitoring a partner company27 If the similar

transactions are repeated frequently learning effects and economies of scale occur

and will reduce the transaction costs

32 Eclectic Theory

The eclectic theory28 (or OLI paradigm) was developed by John Dunning and is a

framework that merges different economic theories which explain foreign market

entry patterns of multinational corporations29 It states that the internationalization

of MNCs is determined by three sets of independent variables ownership

advantages (or firm- specific advantages) location advantages (or country specific

advantages) and internationalization advantages

The ownership advantage considers the competitive advantages of MNCs arising

from firm-specific characteristics such as size monopoly power economies of

scale management brand name technology and other resource capabilities30

These advantages are usually intangible assets and can be transferred at low costs31

The greater the competitive advantage of the MNC is the more likely it is able to

start or to increase its foreign production32

The location advantages arise from country specific benefits that can be divided

into three categories Firstly a host country may have economic advantages

comprising qualitative and quantitative factors such as production transports costs

26 Dietrich (1994) p18 27 Brouthers and Brouthers (2003) p1183 - 1185 28 Dunning (1980) Dunning (1988) Hill Kwang and Kim (1990) 29 Dunning (2002) 30 Forsbaeck and Oxelheim (2004) 31 Griffin and Pustay (2006) 32 Dunning (2002)

9

communication costs market size or tax incentives Secondly a host country may

offer political advantages in particular governmental policies that may influence

market entry Thirdly a host country may provide social and cultural advantages

including the psychic distance between the foreign and the domestic country as

well as language or cultural aspects that may have an impact on the market entry

decision The higher the attractions of the specific location the more likely it is that

MNCs will exploit their ownership advantage by entering the foreign market33

Because of the existence of transactions costs the internationalization incentive

advantage states that it must be profitable for the MNC to exploit these advantages

itself rather than through local companies (eg licensing)34

In economic literature the OLI paradigm has also been applied to the banking

sector In this regard ownership advantage may include easy access to a vehicle

currency Locational advantages may include country-specific regulations and

entry barriers Internationalization advantages can be information advantages and

access to local deposit bases35

Many empirical studies on the banking market have utilized the eclectic paradigm

as a basic framework For example a study of bank entry into CEE markets

concludes that the ownership advantages of foreign MNBs are strong compared to

banks in emerging markets and especially when the foreign country experiences a

banking crisis36 An application of the OLI paradigm to the Spanish banking

market has shown that bank size and multinational experience of MNBs favor

stronger commitment in the foreign country whereas distance is an entry barrier37

However theoretical literature also states that in service industries clients close to

the MNBs headquarters may be served from this location whereas clients in distant

markets require a physical presence of the MNB in the foreign country which

favors a foreign market entry with increasing distance38

33 Dunning (2002) 34 Hagen (1997) 35 Yannopoulus (1983) 36 Uiboupin and Sorg (2006) 37 Blandoacuten (1998) 38 Blondoacuten (1998) Terpstra and Yu (1988)

10

33 Strategy of Defensive Expansion

A common approach employed to explain the expansion of MNBs involves the

theory of defensive expansion which is also referred to as the acutefollow-the-

customeracute argument

This theory states that MNBs expand abroad in order to provide services for

domestic clients which are often large enterprises that have entered a foreign

market39 The provision of financial services in the foreign country usually requires

a presence at important economic centres Hence to some degree expanding

corporations impose pressure on their domestic banks to follow-up40

The term acutedefensiveacute is derived from the idea that a failure to expand may lead to a

loss of the client not only in the foreign country but also in the domestic one as

the client may associate with a foreign MNB41 Consequently MNBs which pursue

this strategy seek to prevent losses rather then to generate new profits in the foreign

market42 Furthermore the domestic bank has an incomparable competitive

advantage over banks in the foreign country with regard to the knowledge of

customer needs the respective risk of credit default as well as an interest in cross-

selling products such as financial advisory43

Due to earlier business relationships with the client the domestic bank has reduced

costs for examining the financial capacities of the respective enterprise and thus

can offer cheaper services44 Most foreign entry evidence supports the defensive

expansion theory45

A study on this theory with respect to retail banking has revealed that MNBs

sometimes expand abroad in order to provide banking services to specific

communities46

39 Trend im retail-banking koumlhler 40 Henneberger and Graf (2000) 41 Mullineux and Murinde (2003) 42 Naaborg (2007) 43 Knoop (2006) 44 Bhattacharya (1994) 45 Bhattacharya (1994) Naaborg (2007) 46 Tschoegl (1987)

11

34 Strategy of Offensive Expansion

MNBs that offensively expand abroad primarily seek to increase their customer

base both in the home and in the foreign country Firstly the establishment of

foreign branches and subsidiaries enables the MNB to expand their services to

domestic residents who benefit from the international orientation of the bank

These may include customers that have business partners in the foreign country

Secondly MNBs may target new customers in the foreign country in particular

MNEs or foreign subsidiaries of domestic enterprises As the MNB must in both

cases entice customers away from other banks the MNB has to offer attractive and

competitive conditions for their financial services47

47 Buumlschgen (1998) p604

12

4 Industry Analysis German Retail Banking Sector

41 Porter`s Five Forces

In the school of Industrial Economics the five-forces model has established itself

as a core element of industry analysis Porter`s analysis framework is built on the

following five market forces that shape the strategy of competitors threat of new

entrants threat of substitute products or services bargaining power of buyers and

suppliers as well as rivalry among existing competitors

Porterrsquos concept is based on the knowledge that the strategy of an enterprise must

orient itself to its market environment whereby the competitive strategy arises

from a differentiated understanding of the market structure and the knowledge of

how it changes The effects of these forces determine the intensity of the

competition in a market and with it its profitability and attractiveness Therefore

the aim of the enterprise strategy should be reflected in the search for possibilities

for the reduction or use of these competitive forces relative to its own enterprise In

this regard Porter`s model is conducive to the analysis of the driving forces

working in the respective industry

Figure 2 Michael E Porter`s five forces model (Own illustration based on Porter 1979)

Industry Rivalry

Threat of New

Entrants

Bargaining Power of

Buyers

Threat of Substitute Products

and Services

Bargaining Power of Suppliers

13

Porter`s framework is a useful and frequently utilized analytical tool to describe the

foundations of industry competition

A high degree of rivalry among the existing enterprises leads to high competitive

pressure and can lower profit margins and the profitability of individual

enterprises In situations in which a large number of enterprises target similar

market segments with comparable strategies in which the market grows slowly

price is the most important differentiation factor and high exit barriers exist a

negative impact on the industryrsquos profitability is effected48

The threat of new entrants can be determined by the entry barriers of a market The

competitive pressure on existing enterprises increases with low entry barriers In

such a situation important elements of the market (eg shares of the market price

level) can change due to the entry of new market participants49

The bargaining power of buyers determines to what extent customers can influence

enterprises by the amount of consumption and the pressure on margins Important

indexes of a high degree of buyer power include high fixed costs in the industry

existence of supplements of the product or service high degree of customer

concentration customers` knowledge of production costs possibility of a reverse

integration of customers high growth rates of the market and a strong

individualization of customer demand50

The bargaining power of suppliers affects industry profitability if for example a

concentrated supplier group dominates over existing enterprises in the market

which are not important buyers for the suppliers Then the industry faces high

margin pressure by the suppliers

A threat of substitute products and services exists in particular if cheaper or higher-

quality products and services are able to reduce existing sales volumes of a market

or an enterprise51 The future sales potential of existing enterprises becomes limited

and industry competition increases

48 Porter (1985) 49 Porter (1979) Recklies (2001) 50 Recklies (2001) 51 Recklies (2001)

14

Critics of this model state that it neglects the impact of complements as a sixth

force of the industry since they may facilitate or hinder the commercialization of

certain goods However Porter argues that complements are not a force itself but

they affect profitability in the way that they influence the five forces and that `the

strategist must trace the positive or negative influence of complements on all five

forces to ascertain their impact on profitability`52

One limitation of this model is based on studies which indicate that company-

specific factors may have a more important impact on profit than industry forces53

Furthermore the model suggests relatively static and stable market structure which

makes it difficult to assess contemporary dynamic markets54

The model does not assess the impact of the parent company on its subsidiary

which is especially important in the banking sector in which parent companies

often have a strong impact on the performance of their subsidiary or branch The

parenting advantage includes the stand-alone influence through monitoring and

influence on management decisions or capital expenses Furthermore parents

create value by enhancing synergies within the group offering corporate functions

or managing portfolios55

42 Rivalry among existing competitors

In this section the intensity of competitive rivalry among existing competitors in

the German retail banking sector is discussed In this regard an analysis of industry

structure industry growth and exit barriers will be conducted

Industry structure The German banking market is characterized by a three-pillar

system which is reflected by the strict distinction between public-law banks

cooperative banks and private banks56 Each pursues different goals and is subject

to different regulations Private commercial banks pursue the goal of profit

maximization whereas saving banks serve the public contract of offering secure

52 Porter (1997)p11 53 Zack (1999) 54 Recklies (2001) 55 Goold Cambpell and Alexander (1994) 56 Gramlich (2005)

saving possibilities and loans C

interest of their members

banking market is structured as follow

Figure 3(own illustration based on Sch

Public-law banks including saving banks and state banks

total balance sheet volume of banks in Germany

do not participate in retail banking The cooperative bank sector amounts to 11

the total including cooperative banks

cooperative central banks

commercial banks including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

31 of total balance sheet volume

European Research (ZWE) 43 of experts state that the three

important or very important and

for the low number of cross

In order to describe industry rivalry among maj

retail sector the following table illustrates the number of customers per bank in

Germany

57 Engerer (2006) 58 Koumlhler (2008b)

banks 24

Private commercial banks 31

15

possibilities and loans Cooperative banks primarily serve the economic

interest of their members57 In terms of total balance sheet volume the German

banking market is structured as follows

Figure 3 Structure of the German Banking Sector(own illustration based on Schrooten 2009)

law banks including saving banks and state banks amount to 33 of the

total balance sheet volume of banks in Germany However state banks

do not participate in retail banking The cooperative bank sector amounts to 11

including cooperative banks which participate in retail ban

cooperative central banks which primarily serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

alance sheet volume According to a recent survey of the Center for

European Research (ZWE) 43 of experts state that the three-pillar system is

important or very important and 33 state that it is the critical factor responsible

cross-border mergers and acquisitions in Germany

In order to describe industry rivalry among major banks that participate in the

the following table illustrates the number of customers per bank in

Savings banks 13

State banks 20

Cooperative central banks

3Credit cooperative banks 8

Other banks 24

serve the economic

sheet volume the German

Structure of the German Banking Sector

amount to 33 of the

However state banks generally

do not participate in retail banking The cooperative bank sector amounts to 11 of

participate in retail banking and

serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks amount to

According to a recent survey of the Center for

pillar system is

33 state that it is the critical factor responsible

border mergers and acquisitions in Germany58

or banks that participate in the

the following table illustrates the number of customers per bank in

State banks 20

Cooperative central banks

16

Figure 4 Customers of German Banks at the end of 2007 in millions (own illustration based on Deutsche Bank 2008)

With approximately 50 million customers savings banks are the market leader in

the German retail banking sector Although state liability assumption for savings

banks was abolished in 2005 because the EU saw in it an unacceptable subsidy to

the disadvantage of private banks customers still associate the name `Sparkasse`

with state guarantees The specific characteristic of a saving bank is based on its

public contract in that it has to accept customers with poor credit-worthiness that

profits should be used to enhance public wealth and that the middle class should be

supplied with loans59

With approximately 30 million customers cooperative banks are the second major

player in the German retail banking sector Nearly half of these customers are

members of the cooperative banks60 In contrast to the profit maximization goal of

private commercial banks their aim is to fund their members and secure their

economic independence Although cooperative banks are economically and legally

independent in the different regions they appear uniformly as a group under the

brand of ldquoVolks- und Raiffeisenbankenrdquo With regard to growth in customer base

cooperative banks benefit from the advantage of having the regional flexibility that

59 Kruck (2008) 60 Online Raiffeisen Bank Homepage

31

4

61

118

242

30

50

0 10 20 30 40 50 60

Citibank

Hypovereinsbank

ING DiBa

Commerzbank and Dresdner Bank

Postbank and Deutsche Bank

Credit Unions (Volksbanken)

Savings Banks (Sparkassen)

17

allows for topical advertisement as well as a centralized management focus on

improving reputation61

The third group comprises the major private commercial banks including Deutsche

Bank Postbank Commerzbank and Hypovereinsbank Deutsche Bank is a leading

multinational investment bank but with relatively low market share in the retail

banking market Deutsche Bank (97 million clients) is acquiring Postbank (145

million clients) with its broad branch network in a three-step process Together

they have 242 million clients However Heino Ruland from the analyst company

Frankfurt Finanz Partner argues that Deutsche Bank might not be able to capitalize

on the financially weaker Postbank clients as Deutsche Bank is specialized in

corporate clients62 With regard to rivalry intensity and market profitability Rainer

Neske supervisory board member and head of private amp business clients of

Deutsche Bank emphasizes that the German retail banking market is too

fragmented to be highly profitable and that Deutsche Bank does not seek to

compete on the price level but defines itself through performance quality and

consultancy63

Commerzbank is the second largest private commercial bank in Germany After the

acquisition of Dresdner Bank in 2009 Commerzbank now serves more than 12

million clients (of these 11 million private and one million corporate clients) and

pursues the goal of becoming the market leader in Germany64

UniCredit Bank AG with the brand name Hypovereinsbank (HVB) is a subsidiary

of UniCredirSpA and is the third largest private commercial bank in Germany

HVB serves approximately four million clients predominantly in north Germany

and in Bavaria As its retail banking segment could only report marginal profits in

2009 speculation about a sale or acquisition in this segment has come up As the

Swedish SEB (Skandinaviska Enskilda Bank) is considering selling its German

retail segment with 174 branches and one million clients experts now regard HVB

as a major buying candidate65

61 Schwarzbauer (2009) 62 Kreiler (2008) 63 Deutsche Bank (2009) 64 Kreiler (2008) 65 Houmlpner and Nagl (2010)

18

ING DiBa AG is a subsidiary of the Dutch ING Group and serves over 6 million

clients In contrast to savings cooperative and the major private commercial

banks ING DiBa is specialized in direct banking which distributes services via

telephone the internet or post instead of through branches In Germany ING

DiBa is the leader in direct banking but there are many other direct banks such

as Comdirect (a subsidiary of Commerzbank) Volkswagen Bank or DAB Bank

(a subsidiary of HVB) Competition takes place not only among direct banks but

also between direct and branch banks For instance many saving banks have

blocked the opportunity for customers of direct banks to withdraw cash from their

automated teller machines As savings banks can only charge Euro 174 for

withdrawals via visa cards they fear that direct banks can gain market share by

offering attractive account options with a convenient wide-area ATM provision66

Targobank (former Citibank Deutschland) was acquired by the French

cooperative bank Creacutedit Mutel and now serves more than 34 million clients in

Germany in 2010 The bank is specialized in private retail customers with

branches and direct banking67

In conclusion the degree of concentration in the German retail banking market is

very low which reduces the overall profitability of this sector for two main

reasons Banks earn higher profits in concentrated markets as they obtain either

monopoly rents (structure-conduct-performance paradigm) or due to high market

shares that are gained by more efficient and profitable banks (efficient structure

hypothesis)68 As retail banking services are largely standardized product

differentiation is low and price differentiation is often the only option As public-

law banks serve other interests than profit maximization existing private banks

and MNBs that want to enter this market have a competitive disadvantage The

low switching costs of clients intensifies competition on the price level and thus

reduces the profitability of the market However brand identification and

customer relationships are also important which decreases the willingness of

clients to switch solely on the basis of price comparison In summary market

structure indicates a very high degree of rivalry among existing competitors

66 Online Financial Times Deutschland (2010) 67 Targobank (2010) 68 Havrylchyk and Jurzyk (2006) p15

19

Industry growth In this section industry growth will be examined in a dynamic

analysis of three relevant market growth indicators the future long-run

development of the German population the historical development of the number

of banks and branches in Germany and the historical development of market-

share allocation in the context of major retail banking activities

In the long-run market growth depends on the future numerical development of

the market`s customers - the German population As the growth of population

through birth and immigration is smaller than its decrease by virtue of the mortality

rate and emigration the Federal Statistical Office in Germany estimates a sharp

decline of the German population

Figure 5 Estimated Development of German Population (in millions)

(Federal Statistical Office 2009)

The Federal Statistical Office predicts that the trend of decline in population since

2003 will continue and intensify Whereas approximately 82 million people lived

in Germany in 2008 only between 65 million (average lower limit of the

population with 100000 immigrants yearly) and 70 million people (average

upper limit of the population with 200000 immigrants yearly) will reside in

Germany in 2060 Furthermore the decreasing number of births and the ageing of

the current strongly represented middle age group will lead to substantial changes

in the age structure of the population From 2008 to 2060 the proportion of people

from 65 to 80 years will increase 15 to 20 and the proportion of people over

80 years of age will increase from 5 to 14 of the population69 The

69 Federal Statistical Office (2009)

Average lower limit

Average upper limit

20

implications of the aging population for banks will be discussed in the comparison

between direct banks and BampM banks in section 66 of this thesis

The second indicator of industry growth deals with the number of banks and bank

branches in the German market The overall number of banks in Germany

decreased from 3785 in 1995 to 2300 in 2006 As retail banking usually depends

on the number branches maintained their development in Germany will be

examined

Figure 6 Development of Total Bank Branches in Germany (own illustration based on Koumlhler2008a)

Savings banks and cooperative banks have reduced the number of branches

significantly Public-sector banks (savings banks state banks etc) with 18757

branches and cooperative banks with 16028 branches in 1998 reduced the

number of branches to 14252 and 12303 respectively in 2006 Moreover the

number of branches of major commercial banks decreased from 19055 in 1998 to

8879 in 2006

The main cause for the decrease of branches is the high fixed costs which can not

be recouped from low-revenue standard products that can also be distributed

through alternative low-cost channels such as the internet70

70 Koumlhler and Land (2008)

67930 6666363186

59929 58546 5693653931

5086847244 45467 44100

40332

0

10000

20000

30000

40000

50000

60000

70000

80000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

21

As a third indicator of industry growth this paper reflects on the allocation of

market share within the retail banking sector in order to indentify trends that may

affect overall market growth This paper will reflect on market share in two major

retail banking segments - savings deposits and loans The German Central Bank

classifies the banking market in terms of savings banks cooperative banks direct

banks and credit banks The latter include universal banks which are private

commercial banks branches of foreign banks regional banks and other private

banks

This section reflects the development of market share regarding short- medium-

and long-term saving accounts and examines the allocation of loans to corporate

clients consumers (consumer loans) private households and self-employed

persons

In the period from 1998 to 2006 the market for medium-term saving deposits with

a cancellation period under three months has been dominated by saving banks (53

market share in 2006) and cooperative banks (29 market share in 2006) In the

same period the market share for long-term saving deposits with a cancellation

period above three months has also continuously been dominated by savings banks

(65 market share in 2006) and cooperative banks (24 market share in 2006)

However with regard to deposits that mature daily direct banks were able to

increase market share from approximately 15 in 1998 to over 15 in 2006

Figure 7 Market share development of saving accounts that mature daily (own illustration based on Deutsche Bundesbank 2007)

000

500

1000

1500

2000

2500

3000

3500

4000

4500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Banks

Cooperative Banks

Savings Banks

Credit Banks

22

From 1998 to 2006 market share for loans for corporate clients has been

continuously dominated by credit banks (53 market share in 2006) and savings

banks (34 market share in 2006) However this data also comprises loans for

medium and large corporations which are not part of the retail banking market

Loans for private households and self-employed persons have predominately been

granted by savings banks (39 market share in 2006) credit banks (30 market

share in 2006) and cooperative banks (25 market share in 2006) though direct

banks were able to gain some market share from 0 in 1998 up to 5 in 2006

Even more significantly direct banks were able to gain over 16 market share in

the segment of consumer loans

Figure 8 Market share development of consumer loans (own illustration based on Deutsche Bundesbank 2007)

Hence the most significant growth indicator of the retail banking market results

from the emergence of direct banks which were able to gain substantial market

share in consumper loans and deposits that mature daily

In conclusion the industry growth analysis indentifies the following growth

indicators Firstly a sharp decrease in the German population in the following

decades will reduce growth and increase industry rivalry Moreover the

demographic change increases the proportion of old people in the population

Secondly the number of branches in Germany is decreasing due to high fixed

costs of branches In order to be profitable in retail banking the existing branches

must serve a large quantity of customers which leads to strong competition

relative to market share Thirdly the development of market share allocation

000

1000

2000

3000

4000

5000

6000

7000

2002 2003 2004 2005 2006

Savings Banks

Cooperative Banks

Direct Banks

Credit Banks

23

indicates that only direct banks have experienced significant growth from 1995 to

2006

Exit barriers From a perspective of Transaction Costs Economics one can argue

that exit barriers in branch banking are high for market participants as branches

and staff are highly specific assets that lose value when used in another situation

To a large extent these assets are locked into the context of retail banking

Moreover public-law banks usually have to serve the population regardless of

whether they are profitable or not In a situation in which a bank continuously

experiences losses staff and branches may be considered as sunk costs and thus

economically `irrationalacute exit barriers However theories suggest that staff and

branches are practically valid exit barriers and cause MNCs to stay in a market71

The high degree of exit barriers intensifies the strong rivalry among existing

competitors

43 Threat of New Entrants

New entrants usually seek to gain market share while applying pressure on prices

and costs and thus increasing the investments necessary to compete An expert

survey conducted by the ZEW emphasizes the importance of entry threat to the

German retail-banking market 6666 of market experts state that new

competitors (eg foreign banks) have an important or a very important impact on

industry rivalry72

In this section the threat of new entrants to existing market participants in the

German retail banking sector is discussed In this regard this section evaluates

legal entry barriers capital requirements the necessity of large scale operations

customer switching costs and incumbency advantages of existing domestic banks

Legal entry barriers are determined by governmental regulations in the German

Banking Act (GBA) and are supervised by the Federal Supervisory Authority73

According to section 32 para 1 (1) GBA companies that intend to pursue

commercial banking transactions or financial services in Germany require written

71 Hill Hwang and Kim (1990) 72 Koumlhler and Lang (2008) 73 Bundesanstalt fuumlr Finanzdienstleistungsaufsicht (2005)

24

permission from the Federal Financial Supervisory Authority ( ldquoBundesanstalt fuumlr

Finanzdienstleistungaufsichtrdquo) The execution of banking transactions or financial

services also exists when the operator has its headquarters or primary residence

abroad but repeatedly targets companies or individuals who have their primary

residence in Germany In order to obtain the permit several requirements are

examined (eg business plan qualified management etc)

Companies from third countries which intend to conduct banking transactions and

provide financial services in Germany must establish a subsidiary (section 32 para

1 in connection with ection 33 para 1 (6) GBA) or a branch (section 32 para 1 in

connection with section 53 GBA) in Germany Companies from third countries can

apply for an exemption according to section 2 para 4 GBA if the company is

supervised utilizing international accounting standards in the home country and the

responsible authority works together with the BaFin According to section 53b

GBA companies of EEA states are allowed to establish branches (section 53b para

2) but are also free to conduct cross-border financial services without a domestic

presence (section 53b para 2a) Section 32 para 1 GBA does not apply to business

that is motivated by the initiative of the domestic individual or enterprise (so called

passive service freedom)

Representations are limited to their representative function and are not allowed to

conduct or initiate any banking business

Capital requirements are low for cross-border lending and and relatively low for

representations With high equity modes such as branches and even more so with

subsidiaries capital requirements are relatively high as capital is required for

building a broad network of facilities and offering credit to customers Capital

requirements for direct banks are relatively low compared with those of BampM

banks

The necessity of large scale operation is related to the competitive advantage of

economies of scale A company that serves the market in the context of larger

quantities benefits from lower cost per unit In retail banking profit is gained by

having a large number of clients It is expensive to build up these numbers and to

establish a distribution network to serve them This necessity relates directly to the

strategy of the bank An acquisition offers a shortcut to these facilities although the

25

costs of integration can be high as well74 A MNB may also decide to target only a

certain geographical area with certain clients and therefore do not have to enter on

a very large scale

Customer switching costs are different for each individual In general customers

can easily change their banks and open a deposit account or apply for a loan at

another bank However they have to compare the different terms for usually small

transactions to evaluate the convenience of having a bank nearby and then to

decide to terminate the relationships with their current bank75

Finally the incumbency advantages of existing banks are important entry barriers

In particular they include established brand reputation possession of the most

favorable geographical locations and market knowledge Moreover established

banks may already have exclusive contracts with SMEs76

To conclude legal entry barriers are low and particularly low for banks from the

EEA Capital requirements for entering the market are high yet as far as equity

entry modes are concerned direct banks require relatively low capital as they

distribute their services through low-cost channels Banks need to attract many

customers to be profitable but banks strategy dictates whether or not to entrance

should occur on a large scale Moreover the incumbency advantages of existing

banks constitute important entry barriers

44 Threat of Substitute Products or Services

A substitute in retail banking is a service that offers an attractive trade-off to a bank

service or product As individuals and small firms do not regularly report financial

information as do large enterprises they rely primarily on bank lending However

there are additional forms of financing in the private equity or dept market77

Many non- and near- banks provide substitute products and services Near-banks or

quasi-banks are suppliers of financial services but are not classified as credit

institutes according to section 1 GBA Near-banks such as insurance companies or

credit card organizations however do provide substitute products or services Non-

74 Hughes and MacDonald (2009) 75 Adams (2002) 76 Adams (2002) 77 Xiaoqin and Terada-Hagiwara (2003)

26

banks such as department store chains catalog companies or car producers also

provide substitute services78 For instance instead of taking out a loan in order to

pay for a product individuals or small enterprises may decide to take on a leasing

contract for a certain asset or small enterprises can obtain a trade credit as well

Individuals may decide on buying products from insurance companies instead of

putting money into a bank account

Another substitute for both direct and BampM banks is the person-to-person (p2p)

lending business a new form of borrowing and lending money that takes place in a

web-based market place In this online platform borrowers are connected to

lenders through an auction-like process in which a lender who bids to provide a

loan for the lowest interest rate will be awarded the loan contract with the

borrower A p2p company mediates between private or company borrowers and

lenders and also executes transactions between the parties similar to the role which

e-bay plays in the trade of commercial goods79 The p2p lending business does not

involve traditional banks and thus can offer superior interest rates to borrowers and

higher returns for lenders

45 Bargaining Power of Suppliers

When a supplier group is more concentrated than the industry does not primarily

depend on the industry and when the industry faces high switching costs the

supplier group has strong bargaining power and can reduce the profit potential of

an industry In the retail banking market the most relevant suppliers include human

resources suppliers of capital resources and suppliers of information and

communication technology (ICT)80 Highly talented or experienced specialists are

strongly canvassed and have strong bargaining power with respect to their salary

and working conditions However in the aftermath of the financial crisis many

banks are planning a reduction of staff According to a study of Ernst amp Young

every fifth bank intends to decrease staff and only every 10th bank is planning an

increase81 Given the current situation of the employment market the bargaining

power of employees is relatively low Suppliers of highly specialized banking ICT

78 Gabler Wirtschaftslexikon (2010) 79 Deloitte (2009) p 12 80 Buumlschgen and Boumlrner (2003) 81 Ernst amp Young (2009)

27

solutions have strong bargaining power as switching costs for these systems are

very high Moreover the higher yield requirements of shareholders can be

interpreted as supplier power

46 Bargaining Power of Buyers

In retail banking there are many buyers with relatively low transaction volumes

which weakens their bargaining power However retail banking services are

standardized and buyers can easily find similar services Switching costs have

usually been relatively high for these low volume transactions but in the age of the

internet the market is very transparent and buyers can screen different offerings

more easily This does not necessarily imply that the cheapest banking service will

be chosen automatically as customers also seek a trustworthy brand especially in

times of financial crisis Moreover there are other factors that affect the switching

cost of the individual such as the location of the branch Yet there is a tendency

towards the increasing bargaining power of buyers

This is also substantiated by the ZEW survey 7984 of market experts state that

decreasing customer loyalty and increasing price sensibility are important or very

important factors with respect to the intensity of competition in the German retail

banking sector A comparison of former and modern retail customers also indicates

that the bargaining power of retail banking service users has increased

Former Retail Customer Modern Retail Customer

Passive information seeking

behavior

Active information seeking behavior

Hardy or little informed Good to very good know-how

High customer loyality Increasing willingness to switch

Fixation on the branch Expects multi-channel banking at all times

and places

Little market transparency High price transparency

Relatively undemanding Demanding

Figure 9 Comparison of former and modern retail customers (own illustration based on Swoboda 2004)

28

5 Foreign Bank Entry Strategies in Germany

This section illustrates mode choices for foreign bank entry in Germany Based on

the hierarchical model of market entry modes82 the foreign bank has the choice of

equity and non ndash equity modes of entry An advantage of the hierarchical model is

that it allows comparing between entry modes on different levels The main

difference between equity and non ndash equity modes is the degree of resource

commitment in the foreign country As classified at the beginning of this thesis

non-equity entry refers to international banking and equity entry refers to

multinational banking

The research question of this thesis considers multinational bank entry modes

International banking however is often a first step towards multinational banking

Hence this thesis will also discuss cross-border lending and alliances as non ndash

equity entry modes The following figure illustrates a comprehensive view of

market entry modes for banks

Figure 10 A hierarchical model of entry mode choices for banks (own illustration based on Pan and Tse 2000)

82 Pan and Tse (2000)

Entry Mode Choices

Non - Equity Modes

Export

Cross Border Lending

Contractual Agreements

Alliances

Equity Modes

Equity Joint Ventures

Greenfield Investment

Branch

Subsidiary

Representation

Acquisition

Subsidiary

Branch

29

The hierarchical model illustrates the various entry mode choices for entering the

German retail banking market The creation of a common European financial

market in which banks can integrate freely is a major goal of the European Union83

The previous section of this paper indicates that entry barriers are relatively low

and that the German market is highly competitive Hence the choice of a proper

entry mode which is appropriate to the capabilities and the strategy of the bank is

even more significant Therefore the following section will reflect on the strategic

concept governing the choice of entry modes as well as the proliferation of these

entry modes in the German retail banking market

An international bank that is not interested in investing equity in the foreign

market can enter by means of cross-border lending or by forming a non-equity

alliance These non-equity entry modes can help the bank to access niche markets

or to exploit locational advantages when the bank is located near the German

border

However a retail bank defined in the beginning of this paper as a bank that

`caters for ordinary individuals and small businessacute and that seeks to enter the

German market in order to gain significant revenue from deposits and loan

business might have to consider a physical presence in the foreign country

The analysis considers entry modes that are perceived as international banking

cross-border lending and non-equity strategic alliances Furthermore the equity

modes JVs and representations will be discussed

Subsequently this section compares the market entry of a branch through

Greenfield investment with the market entry of a subsidiary by virtue of

acquisition as these modes of entry are the most common in the German retail

banking market

Finally the following question will be addressed to what extent do demographic

and technical trends favor a direct bank entry mode over a brick and mortar bank

approach in Germany

83 Fidrmuc and Hainz (2008)

30

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks (own illustration)

51 Non ndash equity modes Export ndash Cross-Border Lending

Cross-border lending is equivalent to the export entry mode and is a simple non-

equity strategy to enter a foreign market A bank which participates in cross-

border lending must assess the creditworthiness of the individual borrower as well

as the country risk which involves the possibility that these loans will be impaired

by economic or political proceedings in the foreign country84 The country risk in

Germany is rather low as it is perceived to have a solid political and economic

situation (Country Rating A2) with a stable and a very efficient business

environment (Country Rating A1)85 As a bank will only have limited access to soft

information about the creditworthiness of the borrower the availability of loans

usually decreases and the interest on loans usually increases with distance86 Soft

information for private loans includes the previous experience with the account

management of the credit user environmental facts and a judgment relative to his

employment contract87 For corporate loans soft facts may include the market

environment corporate structure management a business plan as well as

84 Hughes and McDonald (2003) 85 Online wwwtrade-safelycom (2009) 86 Agrawal and Hauswald (2007) 87 Dizil (2009)

Entry Mode Choices of MNBs

Greenfield Investment

Branch

Brick and Mortar Bank Direct Bank

Acquisition

Subsidiary

Brick and Mortar Bank Direct Bank

VIII

List of Figures

Figure 1 Classification of retail banking clients 6

Figure 2 Michael E Porter`s Five Forces model 12

Figure 3 Structure of the German banking sector 15

Figure 4 Customers of German banks at the end of 2007 (in millions) 16

Figure 5 Estimated development of the German population (in millions) 19

Figure 6 Development of total bank branches in Germany 20

Figure 7 Market share development of accounts that mature daily 21

Figure 8 Market share development of consumer loans 22

Figure 9 Comparison of former and modern retail banking customers 27

Figure 10 A hierarchical model of entry mode choices for banks 28

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks 30

Figure 12 Development of foreign MNBs branches in Germany 35

Figure 13 Development of foreign MNBs subsidiaries in Germany 37

Figure 14 SWOT analysis 47

Figure 15 Service Marketing Mix 51

IX

List of abbreviations

ATM Automated Teller Machine

BampM Brick and Mortar

CEE Central and Easter European

EEA European Economic Area

FDI Foreign Direct Investment

GBA German Banking Act

ICT Information and Communication Technology

JV Joint Venture

MNB Multinational Bank

MNE Multinational Enterprise

RDC Remote Deposit Capture

SMEs Small and Medium Sized Enterprises

TCE Transaction Costs Economics

WOS Wholly Owned Subsidiary

ZEW Centre for European Economic Research

1 Introduction

In the aftermath of the recent financial crisis1 and in times in which banks

rediscover the private individual ndash also described as the renaissance of retail

banking2 - significant attention is now being paid to the market entries of foreign

multinational banks3

The German retail banking market is highly competitive Private cooperative and

state-controlled savings banks compete intensely for market share with hardly any

cooperative activities among the groups As savings banks are owned by German

states towns or local authorities they are protected by law from takeovers by

institutes from the other banking sectors4 Due to the high fragmentation of the

German market hardly any bank has dominant market power The five largest

banks have a total market share of only 20 percent and new competitors enter the

market and attract customers with aggressive price differentiation offers5 The

strong competition among private banks savings banks and co-operative banks

results in low profit margins by international comparison The profit potential in

German private-customer business has fallen for many years From 2000 to 2006

total income from the financial service providers in Germany measured by the

distribution of financial products with private customers fell approximately 15

from euro 675 billion to euro 574 billion6 Though the retail banking sector has

experienced some increase in profits due to cost reduction and reduced loan

failures in 2007 market potential still stagnated in 20097

Since the financial crisis has raised the awareness of the threats of investment

banking many banks have refocused on core business activities in order to

maintain their solvency through increased account deposits Banks need money to

grant loans to private individuals or enterprises provide investment opportunities

finance consumer goods or simply realize baking transactions Yet the recent

financial crisis caused distrust among the banks and loans will not be granted as

1 Plickert (2009) 2 Deutsche Bank (2009) 3 Koumlhler and Lang (2008) 4 Spiegel Online (2007) 5 Welp (2009) 6 Zebrolfesschierenbeckaccosiates (2008) 7 McKinsey amp Company (2007) Zebrolfesschierenbeckaccosiates (2008)

2

easily as before On the consumer side the financial crisis has increased the

demand for secure money investments A survey of 230 highly ranked managers

from private savings and co-operative banks on the effects of the crisis on their

business indicates that banks have concentrated more intensively on business with

private customers both during and after the latest crisis Moreover customer

demand for certificates company shares or funds has fallen significantly while the

demand for standard retail banking products such as call money accounts or

account books has increased substantially8

In spite of its high competitiveness and low profit margins the German retail

banking market is still attractive for foreign banks Foreign MNBs are increasingly

able to penetrate the market for private individuals9 In particular they gain market

share through new products decreasing prices standardized processes and

innovative marketing whereas domestic banks have often relied on continued

customer loyalty10 Although foreign multinational banks in Germany have usually

concentrated on large domestic corporations engaged in international

transactions11 they now enter the market for private and small corporate clients as

well12- a trend that has been supported by the development of internet technology

and other new marketing - channel options

The distinctive characteristics of the German banking market raise several

questions concerning both entry mode and business model considerations of

multinational banks Should a multinational bank engage in cross-border lending or

rather enter the market via foreign direct investment How do the development of

economic political-legal and social-cultural factors in the German market affect a

multinational bank`s entry mode and business model choice

This thesis distinguishes between the non - equity entry modes of cross-border

lending and alliances as well as the equity entry modes of representative offices

branches subsidiaries and JVs both from a Greenfield investment and an

acquisition point of view Each of these organizational entry mode forms has

8 Welp (2009) 9 Reitz (2005) 10 McKinsey amp Company (2007) 11 Hersh and Weller (2002) 12 Koumlhler (2008)

3

distinctive advantages and disadvantages Hence the main focus of this thesis is to

provide a broad understanding of the distinctive market entry and penetration

strategies in light of macro and micro economical developments in Germany

11 Research Objective

This thesis examines entry mode choice decisions and business model

considerations of multinational banks entering the German retail banking sector

The objective is to evaluate the affect of current market developments on their

entry mode decisions

In light of the financial crisis and the banks` rediscovery of the private individual

the German banking sector is currently experiencing a renaissance resulting in

increasing industry rivalry At the same time the processing of bank transactions

and customer services is becoming increasingly independent of the branch

distribution channel and the adoption of new technologies is substantially affecting

the allocation of retail banking services13 The technological evolution is

exemplified by the emergence of web-based direct banks which have been able to

penetrate the retail banking market with low-cost structures innovative ideas and

distinctive service thinking

Eventually the growing importance of the internet and other technological means

as distribution channels on the one hand and the remaining strong demand for

personal consultation on the other hand require a customer-oriented multi-channel

management of the banks14

This paper contrasts the two opposing ends in the field of retail banking

distribution channels It simplifies the entry mode choice between direct banks that

solely operate through the internet and brick amp mortar banks which solely operate

through a branch network Furthermore it differentiates between branch entry via

Greenfield investment and subsidiary entry via acquisition

Two major questions will be addressed

13 Deloitte (2010) 14 Welp (2009)

4

Firstly to what extent do demographic and technical developments favor a direct

bank entry mode over a brick and mortar bank approach in Germany

Secondly what affects the decision in favor of a branch entry mode via Greenfield

investment as compared to a subsidiary entry mode via acquisition in Germany

12 Structure

This thesis is systematically divided into two different complexes - a theoretical

and a practical After a classification of essential banking terms in the section 2

Section 3 then describes relevant market entry theories ndash namely the Transaction

Costs Theory and the Eclectic Theory as well as market entry strategies ndash namely

the offensive and the defensive strategies of expansion

In section 4 the German retail banking market is analyzed within the five forces

framework The goal of this examination is to evaluate market attractiveness and to

identify micro and macroeconomic developments that may shape the market in the

future

Given the theoretical framework of section 3 and the knowledge of industry

structure and trends of section 4 section 5 explores the decision driving factors of

entry mode choice In this section cross-border lending alliances joint ventures

and representations will be discussed Furthermore this section indicates what

affects the decision in favor of a branch entry mode via Greenfield investment as

compared to a subsidiary entry mode via acquisition and to what extent

demographic and technical developments favors a direct bank entry mode over a

brick and mortar bank entry mode in Germany

Section 6 introduces the SWOT analysis as well as the Service Marketing Mix and

applies these concepts to the ING - DiBa case study It illustrates how ING- DiBa

penetrated the German retail banking market with both the implementation of the

direct banking business model and the exploitation of external opportunities

Finally this thesis concludes with a summary of the major findings

5

2 Classification of Banks

21 Bank

This paper refers to banks as defined in the German Banking Act Section 1 GBA

defines financial institutes as enterprises which pursue banking transactions

insofar as the extent of these transactions requires commercial business operations

At least one of the following transactions has to be carried out security

transactions credit transactions payments transactions or other banking business

The enterprise which pursues banking transactions in Germany requires the

permission of the BaFin (Federal Institution for Finance Service Supervision)

according to section 32 GBA

22 Direct Bank

Direct banks are credit institutes which operate without a branch network and

utilize the internet and the telephone as direct communication channels through

which banking transactions are realized and marketing and customer service takes

place Thus direct banks establish cost advantages which they usually transmit in

the form of attractive terms15

23 Brick and Mortar Bank

A brick and mortar (BampM) company is a traditional street-side business that

deals with its customers face to face in an office that the company owns or rents16

A brick and mortar bank serves consumers in a physical facility as distinct from

providing online or telephone services only The term brick and mortar is not a

generally valid classification of a bank but in the jargon of e-commerce it is

frequently employed to distinguish from internet based enterprises In this thesis

the term brick and mortar bank is employed to differentiate between a direct bank

that operates through direct channels and one which operates solely through its

branch network The term brick and mortar is also distinguished from the term

click and mortar which is an expression for a form of multi-channel retailing in

15 Deutsche Bundesbank (2010) 16 Investopedia Dictionary (2010)

6

which both electronic distribution channels (click) and physical premises (mortar)

are utilized17

24 Multinational Bank

Multinational banks are defined as banks that have a physical presence in more

than one country In contrast international banks engage in cross-border operations

but do not establish a physical presence in foreign countries18

25 Retail Bank

There is no generally valid classification of retail banking in theoretical literature

or in practice19 A distinction in retail banking is often made with regard to its

target clientele In this regard some authors define retail banking as the offering of

banking and financial services to individuals and small and medium sized

enterprises20 Other sources define retail banking as the provision of these services

solely to individuals21 This paper employs the following classification of retail

banks `A retail bank is a bank that caters for ordinary individuals and small

business as distinct from large corporations Retail banking operations offer

deposit facilities lend money transfer funds and are prepared to deal in relatively

small amounts`22 In contrast to private and corporate banking retail banking

considers private clients with low to average income as well as small corporate

clients

2

Figure 1 Classification of retail banking clients

(own illustration based on Swoboda 2004)

17 Gabler Wirtschaftslexikon (2010) 18 Hersh and Weller (2002) 19 Muumlller and Joumlhnk (2005) 20 Pond (2007) FinanceWiki (2008) Tremblay and Tremblay (2007) 21 Frei Harker and Hunter (1998) Online Businessdictionarycom (2010) Investoglossarycom (2010) 22 Essvale Corporation Limited (2007)

Retail Banking

Medium and large corporate clients

Wealthy private clients

Small Corporate clients

Private clients

7

3 Market Entry Theories and Strategies

31 Transaction Costs Theory

In the transaction cost theory developed by Ronald Coase and Oliver E

Williamson a comparison of transaction costs determines the optimal form of

organization In TC Theory the entry mode decision is a tradeoff between the

control and the costs of resource commitment Entry modes vary in three major

aspects the cost of resource commitment control as the level of ownership and

environmental risks that may affect the committed resources Hence high-control

modes increase both risk and the potential return23

Williamson differentiates between ex-ante and ex-post transaction costs

Information and searching costs are incurred ex-ante in the process of collecting

market information and identifying suitable partners Negotiation and contract

costs arise ex-ante due to negotiations legal advisory and the determination of

contractual terms Monitoring costs develop ex-post for activities which serve to

control contractual obligations Conflict and enforcement costs arise ex-post due to

the different interpretation of the contract and the costs of enforcing contractual

regulations with sanctions negotiations or through court proceedings Adaption

costs are incurred due to ex-post changes in contractual agreements that become

necessary because of unpredictable developments24

TCE assumes the existence of bounded rationality and opportunism Bounded

rationality describes the limitation in human processing of information and the

planning of possible outcomes Opportunism describes the notion that humans may

act in a self-interested manner by manipulating information and being dishonest

The consequences of these assumptions are incomplete contracts and moral

hazards25 Vice versa opportunism occurs because firms can not write complete

contracts

The size of the transaction costs is determined in each case by the characteristics of

asset specificity uncertainty and frequency Asset specificity arises when the actor

in the market undertakes specific investments in order to fulfill his contractual 23 Chen and Mujtaba (2007) p322 24 Kieser and Ebers (2006) p278 25 Magill and Quenzii (1996) p11

8

obligations It refers to the degree to which long-lasting human or physical assets

are bound in a specific relationship and thus to the extent to which they provide

value in the context of a different situation26 In TCE markets can hardly solve the

problems that high uncertainty creates in combination with bounded rationality and

threats of opportunism Uncertainty includes environmental and behavioral

uncertainty Environmental uncertainty refers to political legal cultural and

economic uncertainties that may affect the success of business transactions

Behavioral uncertainty states that bounded rationality and the threat of opportunism

result in the high costs of monitoring a partner company27 If the similar

transactions are repeated frequently learning effects and economies of scale occur

and will reduce the transaction costs

32 Eclectic Theory

The eclectic theory28 (or OLI paradigm) was developed by John Dunning and is a

framework that merges different economic theories which explain foreign market

entry patterns of multinational corporations29 It states that the internationalization

of MNCs is determined by three sets of independent variables ownership

advantages (or firm- specific advantages) location advantages (or country specific

advantages) and internationalization advantages

The ownership advantage considers the competitive advantages of MNCs arising

from firm-specific characteristics such as size monopoly power economies of

scale management brand name technology and other resource capabilities30

These advantages are usually intangible assets and can be transferred at low costs31

The greater the competitive advantage of the MNC is the more likely it is able to

start or to increase its foreign production32

The location advantages arise from country specific benefits that can be divided

into three categories Firstly a host country may have economic advantages

comprising qualitative and quantitative factors such as production transports costs

26 Dietrich (1994) p18 27 Brouthers and Brouthers (2003) p1183 - 1185 28 Dunning (1980) Dunning (1988) Hill Kwang and Kim (1990) 29 Dunning (2002) 30 Forsbaeck and Oxelheim (2004) 31 Griffin and Pustay (2006) 32 Dunning (2002)

9

communication costs market size or tax incentives Secondly a host country may

offer political advantages in particular governmental policies that may influence

market entry Thirdly a host country may provide social and cultural advantages

including the psychic distance between the foreign and the domestic country as

well as language or cultural aspects that may have an impact on the market entry

decision The higher the attractions of the specific location the more likely it is that

MNCs will exploit their ownership advantage by entering the foreign market33

Because of the existence of transactions costs the internationalization incentive

advantage states that it must be profitable for the MNC to exploit these advantages

itself rather than through local companies (eg licensing)34

In economic literature the OLI paradigm has also been applied to the banking

sector In this regard ownership advantage may include easy access to a vehicle

currency Locational advantages may include country-specific regulations and

entry barriers Internationalization advantages can be information advantages and

access to local deposit bases35

Many empirical studies on the banking market have utilized the eclectic paradigm

as a basic framework For example a study of bank entry into CEE markets

concludes that the ownership advantages of foreign MNBs are strong compared to

banks in emerging markets and especially when the foreign country experiences a

banking crisis36 An application of the OLI paradigm to the Spanish banking

market has shown that bank size and multinational experience of MNBs favor

stronger commitment in the foreign country whereas distance is an entry barrier37

However theoretical literature also states that in service industries clients close to

the MNBs headquarters may be served from this location whereas clients in distant

markets require a physical presence of the MNB in the foreign country which

favors a foreign market entry with increasing distance38

33 Dunning (2002) 34 Hagen (1997) 35 Yannopoulus (1983) 36 Uiboupin and Sorg (2006) 37 Blandoacuten (1998) 38 Blondoacuten (1998) Terpstra and Yu (1988)

10

33 Strategy of Defensive Expansion

A common approach employed to explain the expansion of MNBs involves the

theory of defensive expansion which is also referred to as the acutefollow-the-

customeracute argument

This theory states that MNBs expand abroad in order to provide services for

domestic clients which are often large enterprises that have entered a foreign

market39 The provision of financial services in the foreign country usually requires

a presence at important economic centres Hence to some degree expanding

corporations impose pressure on their domestic banks to follow-up40

The term acutedefensiveacute is derived from the idea that a failure to expand may lead to a

loss of the client not only in the foreign country but also in the domestic one as

the client may associate with a foreign MNB41 Consequently MNBs which pursue

this strategy seek to prevent losses rather then to generate new profits in the foreign

market42 Furthermore the domestic bank has an incomparable competitive

advantage over banks in the foreign country with regard to the knowledge of

customer needs the respective risk of credit default as well as an interest in cross-

selling products such as financial advisory43

Due to earlier business relationships with the client the domestic bank has reduced

costs for examining the financial capacities of the respective enterprise and thus

can offer cheaper services44 Most foreign entry evidence supports the defensive

expansion theory45

A study on this theory with respect to retail banking has revealed that MNBs

sometimes expand abroad in order to provide banking services to specific

communities46

39 Trend im retail-banking koumlhler 40 Henneberger and Graf (2000) 41 Mullineux and Murinde (2003) 42 Naaborg (2007) 43 Knoop (2006) 44 Bhattacharya (1994) 45 Bhattacharya (1994) Naaborg (2007) 46 Tschoegl (1987)

11

34 Strategy of Offensive Expansion

MNBs that offensively expand abroad primarily seek to increase their customer

base both in the home and in the foreign country Firstly the establishment of

foreign branches and subsidiaries enables the MNB to expand their services to

domestic residents who benefit from the international orientation of the bank

These may include customers that have business partners in the foreign country

Secondly MNBs may target new customers in the foreign country in particular

MNEs or foreign subsidiaries of domestic enterprises As the MNB must in both

cases entice customers away from other banks the MNB has to offer attractive and

competitive conditions for their financial services47

47 Buumlschgen (1998) p604

12

4 Industry Analysis German Retail Banking Sector

41 Porter`s Five Forces

In the school of Industrial Economics the five-forces model has established itself

as a core element of industry analysis Porter`s analysis framework is built on the

following five market forces that shape the strategy of competitors threat of new

entrants threat of substitute products or services bargaining power of buyers and

suppliers as well as rivalry among existing competitors

Porterrsquos concept is based on the knowledge that the strategy of an enterprise must

orient itself to its market environment whereby the competitive strategy arises

from a differentiated understanding of the market structure and the knowledge of

how it changes The effects of these forces determine the intensity of the

competition in a market and with it its profitability and attractiveness Therefore

the aim of the enterprise strategy should be reflected in the search for possibilities

for the reduction or use of these competitive forces relative to its own enterprise In

this regard Porter`s model is conducive to the analysis of the driving forces

working in the respective industry

Figure 2 Michael E Porter`s five forces model (Own illustration based on Porter 1979)

Industry Rivalry

Threat of New

Entrants

Bargaining Power of

Buyers

Threat of Substitute Products

and Services

Bargaining Power of Suppliers

13

Porter`s framework is a useful and frequently utilized analytical tool to describe the

foundations of industry competition

A high degree of rivalry among the existing enterprises leads to high competitive

pressure and can lower profit margins and the profitability of individual

enterprises In situations in which a large number of enterprises target similar

market segments with comparable strategies in which the market grows slowly

price is the most important differentiation factor and high exit barriers exist a

negative impact on the industryrsquos profitability is effected48

The threat of new entrants can be determined by the entry barriers of a market The

competitive pressure on existing enterprises increases with low entry barriers In

such a situation important elements of the market (eg shares of the market price

level) can change due to the entry of new market participants49

The bargaining power of buyers determines to what extent customers can influence

enterprises by the amount of consumption and the pressure on margins Important

indexes of a high degree of buyer power include high fixed costs in the industry

existence of supplements of the product or service high degree of customer

concentration customers` knowledge of production costs possibility of a reverse

integration of customers high growth rates of the market and a strong

individualization of customer demand50

The bargaining power of suppliers affects industry profitability if for example a

concentrated supplier group dominates over existing enterprises in the market

which are not important buyers for the suppliers Then the industry faces high

margin pressure by the suppliers

A threat of substitute products and services exists in particular if cheaper or higher-

quality products and services are able to reduce existing sales volumes of a market

or an enterprise51 The future sales potential of existing enterprises becomes limited

and industry competition increases

48 Porter (1985) 49 Porter (1979) Recklies (2001) 50 Recklies (2001) 51 Recklies (2001)

14

Critics of this model state that it neglects the impact of complements as a sixth

force of the industry since they may facilitate or hinder the commercialization of

certain goods However Porter argues that complements are not a force itself but

they affect profitability in the way that they influence the five forces and that `the

strategist must trace the positive or negative influence of complements on all five

forces to ascertain their impact on profitability`52

One limitation of this model is based on studies which indicate that company-

specific factors may have a more important impact on profit than industry forces53

Furthermore the model suggests relatively static and stable market structure which

makes it difficult to assess contemporary dynamic markets54

The model does not assess the impact of the parent company on its subsidiary

which is especially important in the banking sector in which parent companies

often have a strong impact on the performance of their subsidiary or branch The

parenting advantage includes the stand-alone influence through monitoring and

influence on management decisions or capital expenses Furthermore parents

create value by enhancing synergies within the group offering corporate functions

or managing portfolios55

42 Rivalry among existing competitors

In this section the intensity of competitive rivalry among existing competitors in

the German retail banking sector is discussed In this regard an analysis of industry

structure industry growth and exit barriers will be conducted

Industry structure The German banking market is characterized by a three-pillar

system which is reflected by the strict distinction between public-law banks

cooperative banks and private banks56 Each pursues different goals and is subject

to different regulations Private commercial banks pursue the goal of profit

maximization whereas saving banks serve the public contract of offering secure

52 Porter (1997)p11 53 Zack (1999) 54 Recklies (2001) 55 Goold Cambpell and Alexander (1994) 56 Gramlich (2005)

saving possibilities and loans C

interest of their members

banking market is structured as follow

Figure 3(own illustration based on Sch

Public-law banks including saving banks and state banks

total balance sheet volume of banks in Germany

do not participate in retail banking The cooperative bank sector amounts to 11

the total including cooperative banks

cooperative central banks

commercial banks including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

31 of total balance sheet volume

European Research (ZWE) 43 of experts state that the three

important or very important and

for the low number of cross

In order to describe industry rivalry among maj

retail sector the following table illustrates the number of customers per bank in

Germany

57 Engerer (2006) 58 Koumlhler (2008b)

banks 24

Private commercial banks 31

15

possibilities and loans Cooperative banks primarily serve the economic

interest of their members57 In terms of total balance sheet volume the German

banking market is structured as follows

Figure 3 Structure of the German Banking Sector(own illustration based on Schrooten 2009)

law banks including saving banks and state banks amount to 33 of the

total balance sheet volume of banks in Germany However state banks

do not participate in retail banking The cooperative bank sector amounts to 11

including cooperative banks which participate in retail ban

cooperative central banks which primarily serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

alance sheet volume According to a recent survey of the Center for

European Research (ZWE) 43 of experts state that the three-pillar system is

important or very important and 33 state that it is the critical factor responsible

cross-border mergers and acquisitions in Germany

In order to describe industry rivalry among major banks that participate in the

the following table illustrates the number of customers per bank in

Savings banks 13

State banks 20

Cooperative central banks

3Credit cooperative banks 8

Other banks 24

serve the economic

sheet volume the German

Structure of the German Banking Sector

amount to 33 of the

However state banks generally

do not participate in retail banking The cooperative bank sector amounts to 11 of

participate in retail banking and

serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks amount to

According to a recent survey of the Center for

pillar system is

33 state that it is the critical factor responsible

border mergers and acquisitions in Germany58

or banks that participate in the

the following table illustrates the number of customers per bank in

State banks 20

Cooperative central banks

16

Figure 4 Customers of German Banks at the end of 2007 in millions (own illustration based on Deutsche Bank 2008)

With approximately 50 million customers savings banks are the market leader in

the German retail banking sector Although state liability assumption for savings

banks was abolished in 2005 because the EU saw in it an unacceptable subsidy to

the disadvantage of private banks customers still associate the name `Sparkasse`

with state guarantees The specific characteristic of a saving bank is based on its

public contract in that it has to accept customers with poor credit-worthiness that

profits should be used to enhance public wealth and that the middle class should be

supplied with loans59

With approximately 30 million customers cooperative banks are the second major

player in the German retail banking sector Nearly half of these customers are

members of the cooperative banks60 In contrast to the profit maximization goal of

private commercial banks their aim is to fund their members and secure their

economic independence Although cooperative banks are economically and legally

independent in the different regions they appear uniformly as a group under the

brand of ldquoVolks- und Raiffeisenbankenrdquo With regard to growth in customer base

cooperative banks benefit from the advantage of having the regional flexibility that

59 Kruck (2008) 60 Online Raiffeisen Bank Homepage

31

4

61

118

242

30

50

0 10 20 30 40 50 60

Citibank

Hypovereinsbank

ING DiBa

Commerzbank and Dresdner Bank

Postbank and Deutsche Bank

Credit Unions (Volksbanken)

Savings Banks (Sparkassen)

17

allows for topical advertisement as well as a centralized management focus on

improving reputation61

The third group comprises the major private commercial banks including Deutsche

Bank Postbank Commerzbank and Hypovereinsbank Deutsche Bank is a leading

multinational investment bank but with relatively low market share in the retail

banking market Deutsche Bank (97 million clients) is acquiring Postbank (145

million clients) with its broad branch network in a three-step process Together

they have 242 million clients However Heino Ruland from the analyst company

Frankfurt Finanz Partner argues that Deutsche Bank might not be able to capitalize

on the financially weaker Postbank clients as Deutsche Bank is specialized in

corporate clients62 With regard to rivalry intensity and market profitability Rainer

Neske supervisory board member and head of private amp business clients of

Deutsche Bank emphasizes that the German retail banking market is too

fragmented to be highly profitable and that Deutsche Bank does not seek to

compete on the price level but defines itself through performance quality and

consultancy63

Commerzbank is the second largest private commercial bank in Germany After the

acquisition of Dresdner Bank in 2009 Commerzbank now serves more than 12

million clients (of these 11 million private and one million corporate clients) and

pursues the goal of becoming the market leader in Germany64

UniCredit Bank AG with the brand name Hypovereinsbank (HVB) is a subsidiary

of UniCredirSpA and is the third largest private commercial bank in Germany

HVB serves approximately four million clients predominantly in north Germany

and in Bavaria As its retail banking segment could only report marginal profits in

2009 speculation about a sale or acquisition in this segment has come up As the

Swedish SEB (Skandinaviska Enskilda Bank) is considering selling its German

retail segment with 174 branches and one million clients experts now regard HVB

as a major buying candidate65

61 Schwarzbauer (2009) 62 Kreiler (2008) 63 Deutsche Bank (2009) 64 Kreiler (2008) 65 Houmlpner and Nagl (2010)

18

ING DiBa AG is a subsidiary of the Dutch ING Group and serves over 6 million

clients In contrast to savings cooperative and the major private commercial

banks ING DiBa is specialized in direct banking which distributes services via

telephone the internet or post instead of through branches In Germany ING

DiBa is the leader in direct banking but there are many other direct banks such

as Comdirect (a subsidiary of Commerzbank) Volkswagen Bank or DAB Bank

(a subsidiary of HVB) Competition takes place not only among direct banks but

also between direct and branch banks For instance many saving banks have

blocked the opportunity for customers of direct banks to withdraw cash from their

automated teller machines As savings banks can only charge Euro 174 for

withdrawals via visa cards they fear that direct banks can gain market share by

offering attractive account options with a convenient wide-area ATM provision66

Targobank (former Citibank Deutschland) was acquired by the French

cooperative bank Creacutedit Mutel and now serves more than 34 million clients in

Germany in 2010 The bank is specialized in private retail customers with

branches and direct banking67

In conclusion the degree of concentration in the German retail banking market is

very low which reduces the overall profitability of this sector for two main

reasons Banks earn higher profits in concentrated markets as they obtain either

monopoly rents (structure-conduct-performance paradigm) or due to high market

shares that are gained by more efficient and profitable banks (efficient structure

hypothesis)68 As retail banking services are largely standardized product

differentiation is low and price differentiation is often the only option As public-

law banks serve other interests than profit maximization existing private banks

and MNBs that want to enter this market have a competitive disadvantage The

low switching costs of clients intensifies competition on the price level and thus

reduces the profitability of the market However brand identification and

customer relationships are also important which decreases the willingness of

clients to switch solely on the basis of price comparison In summary market

structure indicates a very high degree of rivalry among existing competitors

66 Online Financial Times Deutschland (2010) 67 Targobank (2010) 68 Havrylchyk and Jurzyk (2006) p15

19

Industry growth In this section industry growth will be examined in a dynamic

analysis of three relevant market growth indicators the future long-run

development of the German population the historical development of the number

of banks and branches in Germany and the historical development of market-

share allocation in the context of major retail banking activities

In the long-run market growth depends on the future numerical development of

the market`s customers - the German population As the growth of population

through birth and immigration is smaller than its decrease by virtue of the mortality

rate and emigration the Federal Statistical Office in Germany estimates a sharp

decline of the German population

Figure 5 Estimated Development of German Population (in millions)

(Federal Statistical Office 2009)

The Federal Statistical Office predicts that the trend of decline in population since

2003 will continue and intensify Whereas approximately 82 million people lived

in Germany in 2008 only between 65 million (average lower limit of the

population with 100000 immigrants yearly) and 70 million people (average

upper limit of the population with 200000 immigrants yearly) will reside in

Germany in 2060 Furthermore the decreasing number of births and the ageing of

the current strongly represented middle age group will lead to substantial changes

in the age structure of the population From 2008 to 2060 the proportion of people

from 65 to 80 years will increase 15 to 20 and the proportion of people over

80 years of age will increase from 5 to 14 of the population69 The

69 Federal Statistical Office (2009)

Average lower limit

Average upper limit

20

implications of the aging population for banks will be discussed in the comparison

between direct banks and BampM banks in section 66 of this thesis

The second indicator of industry growth deals with the number of banks and bank

branches in the German market The overall number of banks in Germany

decreased from 3785 in 1995 to 2300 in 2006 As retail banking usually depends

on the number branches maintained their development in Germany will be

examined

Figure 6 Development of Total Bank Branches in Germany (own illustration based on Koumlhler2008a)

Savings banks and cooperative banks have reduced the number of branches

significantly Public-sector banks (savings banks state banks etc) with 18757

branches and cooperative banks with 16028 branches in 1998 reduced the

number of branches to 14252 and 12303 respectively in 2006 Moreover the

number of branches of major commercial banks decreased from 19055 in 1998 to

8879 in 2006

The main cause for the decrease of branches is the high fixed costs which can not

be recouped from low-revenue standard products that can also be distributed

through alternative low-cost channels such as the internet70

70 Koumlhler and Land (2008)

67930 6666363186

59929 58546 5693653931

5086847244 45467 44100

40332

0

10000

20000

30000

40000

50000

60000

70000

80000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

21

As a third indicator of industry growth this paper reflects on the allocation of

market share within the retail banking sector in order to indentify trends that may

affect overall market growth This paper will reflect on market share in two major

retail banking segments - savings deposits and loans The German Central Bank

classifies the banking market in terms of savings banks cooperative banks direct

banks and credit banks The latter include universal banks which are private

commercial banks branches of foreign banks regional banks and other private

banks

This section reflects the development of market share regarding short- medium-

and long-term saving accounts and examines the allocation of loans to corporate

clients consumers (consumer loans) private households and self-employed

persons

In the period from 1998 to 2006 the market for medium-term saving deposits with

a cancellation period under three months has been dominated by saving banks (53

market share in 2006) and cooperative banks (29 market share in 2006) In the

same period the market share for long-term saving deposits with a cancellation

period above three months has also continuously been dominated by savings banks

(65 market share in 2006) and cooperative banks (24 market share in 2006)

However with regard to deposits that mature daily direct banks were able to

increase market share from approximately 15 in 1998 to over 15 in 2006

Figure 7 Market share development of saving accounts that mature daily (own illustration based on Deutsche Bundesbank 2007)

000

500

1000

1500

2000

2500

3000

3500

4000

4500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Banks

Cooperative Banks

Savings Banks

Credit Banks

22

From 1998 to 2006 market share for loans for corporate clients has been

continuously dominated by credit banks (53 market share in 2006) and savings

banks (34 market share in 2006) However this data also comprises loans for

medium and large corporations which are not part of the retail banking market

Loans for private households and self-employed persons have predominately been

granted by savings banks (39 market share in 2006) credit banks (30 market

share in 2006) and cooperative banks (25 market share in 2006) though direct

banks were able to gain some market share from 0 in 1998 up to 5 in 2006

Even more significantly direct banks were able to gain over 16 market share in

the segment of consumer loans

Figure 8 Market share development of consumer loans (own illustration based on Deutsche Bundesbank 2007)

Hence the most significant growth indicator of the retail banking market results

from the emergence of direct banks which were able to gain substantial market

share in consumper loans and deposits that mature daily

In conclusion the industry growth analysis indentifies the following growth

indicators Firstly a sharp decrease in the German population in the following

decades will reduce growth and increase industry rivalry Moreover the

demographic change increases the proportion of old people in the population

Secondly the number of branches in Germany is decreasing due to high fixed

costs of branches In order to be profitable in retail banking the existing branches

must serve a large quantity of customers which leads to strong competition

relative to market share Thirdly the development of market share allocation

000

1000

2000

3000

4000

5000

6000

7000

2002 2003 2004 2005 2006

Savings Banks

Cooperative Banks

Direct Banks

Credit Banks

23

indicates that only direct banks have experienced significant growth from 1995 to

2006

Exit barriers From a perspective of Transaction Costs Economics one can argue

that exit barriers in branch banking are high for market participants as branches

and staff are highly specific assets that lose value when used in another situation

To a large extent these assets are locked into the context of retail banking

Moreover public-law banks usually have to serve the population regardless of

whether they are profitable or not In a situation in which a bank continuously

experiences losses staff and branches may be considered as sunk costs and thus

economically `irrationalacute exit barriers However theories suggest that staff and

branches are practically valid exit barriers and cause MNCs to stay in a market71

The high degree of exit barriers intensifies the strong rivalry among existing

competitors

43 Threat of New Entrants

New entrants usually seek to gain market share while applying pressure on prices

and costs and thus increasing the investments necessary to compete An expert

survey conducted by the ZEW emphasizes the importance of entry threat to the

German retail-banking market 6666 of market experts state that new

competitors (eg foreign banks) have an important or a very important impact on

industry rivalry72

In this section the threat of new entrants to existing market participants in the

German retail banking sector is discussed In this regard this section evaluates

legal entry barriers capital requirements the necessity of large scale operations

customer switching costs and incumbency advantages of existing domestic banks

Legal entry barriers are determined by governmental regulations in the German

Banking Act (GBA) and are supervised by the Federal Supervisory Authority73

According to section 32 para 1 (1) GBA companies that intend to pursue

commercial banking transactions or financial services in Germany require written

71 Hill Hwang and Kim (1990) 72 Koumlhler and Lang (2008) 73 Bundesanstalt fuumlr Finanzdienstleistungsaufsicht (2005)

24

permission from the Federal Financial Supervisory Authority ( ldquoBundesanstalt fuumlr

Finanzdienstleistungaufsichtrdquo) The execution of banking transactions or financial

services also exists when the operator has its headquarters or primary residence

abroad but repeatedly targets companies or individuals who have their primary

residence in Germany In order to obtain the permit several requirements are

examined (eg business plan qualified management etc)

Companies from third countries which intend to conduct banking transactions and

provide financial services in Germany must establish a subsidiary (section 32 para

1 in connection with ection 33 para 1 (6) GBA) or a branch (section 32 para 1 in

connection with section 53 GBA) in Germany Companies from third countries can

apply for an exemption according to section 2 para 4 GBA if the company is

supervised utilizing international accounting standards in the home country and the

responsible authority works together with the BaFin According to section 53b

GBA companies of EEA states are allowed to establish branches (section 53b para

2) but are also free to conduct cross-border financial services without a domestic

presence (section 53b para 2a) Section 32 para 1 GBA does not apply to business

that is motivated by the initiative of the domestic individual or enterprise (so called

passive service freedom)

Representations are limited to their representative function and are not allowed to

conduct or initiate any banking business

Capital requirements are low for cross-border lending and and relatively low for

representations With high equity modes such as branches and even more so with

subsidiaries capital requirements are relatively high as capital is required for

building a broad network of facilities and offering credit to customers Capital

requirements for direct banks are relatively low compared with those of BampM

banks

The necessity of large scale operation is related to the competitive advantage of

economies of scale A company that serves the market in the context of larger

quantities benefits from lower cost per unit In retail banking profit is gained by

having a large number of clients It is expensive to build up these numbers and to

establish a distribution network to serve them This necessity relates directly to the

strategy of the bank An acquisition offers a shortcut to these facilities although the

25

costs of integration can be high as well74 A MNB may also decide to target only a

certain geographical area with certain clients and therefore do not have to enter on

a very large scale

Customer switching costs are different for each individual In general customers

can easily change their banks and open a deposit account or apply for a loan at

another bank However they have to compare the different terms for usually small

transactions to evaluate the convenience of having a bank nearby and then to

decide to terminate the relationships with their current bank75

Finally the incumbency advantages of existing banks are important entry barriers

In particular they include established brand reputation possession of the most

favorable geographical locations and market knowledge Moreover established

banks may already have exclusive contracts with SMEs76

To conclude legal entry barriers are low and particularly low for banks from the

EEA Capital requirements for entering the market are high yet as far as equity

entry modes are concerned direct banks require relatively low capital as they

distribute their services through low-cost channels Banks need to attract many

customers to be profitable but banks strategy dictates whether or not to entrance

should occur on a large scale Moreover the incumbency advantages of existing

banks constitute important entry barriers

44 Threat of Substitute Products or Services

A substitute in retail banking is a service that offers an attractive trade-off to a bank

service or product As individuals and small firms do not regularly report financial

information as do large enterprises they rely primarily on bank lending However

there are additional forms of financing in the private equity or dept market77

Many non- and near- banks provide substitute products and services Near-banks or

quasi-banks are suppliers of financial services but are not classified as credit

institutes according to section 1 GBA Near-banks such as insurance companies or

credit card organizations however do provide substitute products or services Non-

74 Hughes and MacDonald (2009) 75 Adams (2002) 76 Adams (2002) 77 Xiaoqin and Terada-Hagiwara (2003)

26

banks such as department store chains catalog companies or car producers also

provide substitute services78 For instance instead of taking out a loan in order to

pay for a product individuals or small enterprises may decide to take on a leasing

contract for a certain asset or small enterprises can obtain a trade credit as well

Individuals may decide on buying products from insurance companies instead of

putting money into a bank account

Another substitute for both direct and BampM banks is the person-to-person (p2p)

lending business a new form of borrowing and lending money that takes place in a

web-based market place In this online platform borrowers are connected to

lenders through an auction-like process in which a lender who bids to provide a

loan for the lowest interest rate will be awarded the loan contract with the

borrower A p2p company mediates between private or company borrowers and

lenders and also executes transactions between the parties similar to the role which

e-bay plays in the trade of commercial goods79 The p2p lending business does not

involve traditional banks and thus can offer superior interest rates to borrowers and

higher returns for lenders

45 Bargaining Power of Suppliers

When a supplier group is more concentrated than the industry does not primarily

depend on the industry and when the industry faces high switching costs the

supplier group has strong bargaining power and can reduce the profit potential of

an industry In the retail banking market the most relevant suppliers include human

resources suppliers of capital resources and suppliers of information and

communication technology (ICT)80 Highly talented or experienced specialists are

strongly canvassed and have strong bargaining power with respect to their salary

and working conditions However in the aftermath of the financial crisis many

banks are planning a reduction of staff According to a study of Ernst amp Young

every fifth bank intends to decrease staff and only every 10th bank is planning an

increase81 Given the current situation of the employment market the bargaining

power of employees is relatively low Suppliers of highly specialized banking ICT

78 Gabler Wirtschaftslexikon (2010) 79 Deloitte (2009) p 12 80 Buumlschgen and Boumlrner (2003) 81 Ernst amp Young (2009)

27

solutions have strong bargaining power as switching costs for these systems are

very high Moreover the higher yield requirements of shareholders can be

interpreted as supplier power

46 Bargaining Power of Buyers

In retail banking there are many buyers with relatively low transaction volumes

which weakens their bargaining power However retail banking services are

standardized and buyers can easily find similar services Switching costs have

usually been relatively high for these low volume transactions but in the age of the

internet the market is very transparent and buyers can screen different offerings

more easily This does not necessarily imply that the cheapest banking service will

be chosen automatically as customers also seek a trustworthy brand especially in

times of financial crisis Moreover there are other factors that affect the switching

cost of the individual such as the location of the branch Yet there is a tendency

towards the increasing bargaining power of buyers

This is also substantiated by the ZEW survey 7984 of market experts state that

decreasing customer loyalty and increasing price sensibility are important or very

important factors with respect to the intensity of competition in the German retail

banking sector A comparison of former and modern retail customers also indicates

that the bargaining power of retail banking service users has increased

Former Retail Customer Modern Retail Customer

Passive information seeking

behavior

Active information seeking behavior

Hardy or little informed Good to very good know-how

High customer loyality Increasing willingness to switch

Fixation on the branch Expects multi-channel banking at all times

and places

Little market transparency High price transparency

Relatively undemanding Demanding

Figure 9 Comparison of former and modern retail customers (own illustration based on Swoboda 2004)

28

5 Foreign Bank Entry Strategies in Germany

This section illustrates mode choices for foreign bank entry in Germany Based on

the hierarchical model of market entry modes82 the foreign bank has the choice of

equity and non ndash equity modes of entry An advantage of the hierarchical model is

that it allows comparing between entry modes on different levels The main

difference between equity and non ndash equity modes is the degree of resource

commitment in the foreign country As classified at the beginning of this thesis

non-equity entry refers to international banking and equity entry refers to

multinational banking

The research question of this thesis considers multinational bank entry modes

International banking however is often a first step towards multinational banking

Hence this thesis will also discuss cross-border lending and alliances as non ndash

equity entry modes The following figure illustrates a comprehensive view of

market entry modes for banks

Figure 10 A hierarchical model of entry mode choices for banks (own illustration based on Pan and Tse 2000)

82 Pan and Tse (2000)

Entry Mode Choices

Non - Equity Modes

Export

Cross Border Lending

Contractual Agreements

Alliances

Equity Modes

Equity Joint Ventures

Greenfield Investment

Branch

Subsidiary

Representation

Acquisition

Subsidiary

Branch

29

The hierarchical model illustrates the various entry mode choices for entering the

German retail banking market The creation of a common European financial

market in which banks can integrate freely is a major goal of the European Union83

The previous section of this paper indicates that entry barriers are relatively low

and that the German market is highly competitive Hence the choice of a proper

entry mode which is appropriate to the capabilities and the strategy of the bank is

even more significant Therefore the following section will reflect on the strategic

concept governing the choice of entry modes as well as the proliferation of these

entry modes in the German retail banking market

An international bank that is not interested in investing equity in the foreign

market can enter by means of cross-border lending or by forming a non-equity

alliance These non-equity entry modes can help the bank to access niche markets

or to exploit locational advantages when the bank is located near the German

border

However a retail bank defined in the beginning of this paper as a bank that

`caters for ordinary individuals and small businessacute and that seeks to enter the

German market in order to gain significant revenue from deposits and loan

business might have to consider a physical presence in the foreign country

The analysis considers entry modes that are perceived as international banking

cross-border lending and non-equity strategic alliances Furthermore the equity

modes JVs and representations will be discussed

Subsequently this section compares the market entry of a branch through

Greenfield investment with the market entry of a subsidiary by virtue of

acquisition as these modes of entry are the most common in the German retail

banking market

Finally the following question will be addressed to what extent do demographic

and technical trends favor a direct bank entry mode over a brick and mortar bank

approach in Germany

83 Fidrmuc and Hainz (2008)

30

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks (own illustration)

51 Non ndash equity modes Export ndash Cross-Border Lending

Cross-border lending is equivalent to the export entry mode and is a simple non-

equity strategy to enter a foreign market A bank which participates in cross-

border lending must assess the creditworthiness of the individual borrower as well

as the country risk which involves the possibility that these loans will be impaired

by economic or political proceedings in the foreign country84 The country risk in

Germany is rather low as it is perceived to have a solid political and economic

situation (Country Rating A2) with a stable and a very efficient business

environment (Country Rating A1)85 As a bank will only have limited access to soft

information about the creditworthiness of the borrower the availability of loans

usually decreases and the interest on loans usually increases with distance86 Soft

information for private loans includes the previous experience with the account

management of the credit user environmental facts and a judgment relative to his

employment contract87 For corporate loans soft facts may include the market

environment corporate structure management a business plan as well as

84 Hughes and McDonald (2003) 85 Online wwwtrade-safelycom (2009) 86 Agrawal and Hauswald (2007) 87 Dizil (2009)

Entry Mode Choices of MNBs

Greenfield Investment

Branch

Brick and Mortar Bank Direct Bank

Acquisition

Subsidiary

Brick and Mortar Bank Direct Bank

IX

List of abbreviations

ATM Automated Teller Machine

BampM Brick and Mortar

CEE Central and Easter European

EEA European Economic Area

FDI Foreign Direct Investment

GBA German Banking Act

ICT Information and Communication Technology

JV Joint Venture

MNB Multinational Bank

MNE Multinational Enterprise

RDC Remote Deposit Capture

SMEs Small and Medium Sized Enterprises

TCE Transaction Costs Economics

WOS Wholly Owned Subsidiary

ZEW Centre for European Economic Research

1 Introduction

In the aftermath of the recent financial crisis1 and in times in which banks

rediscover the private individual ndash also described as the renaissance of retail

banking2 - significant attention is now being paid to the market entries of foreign

multinational banks3

The German retail banking market is highly competitive Private cooperative and

state-controlled savings banks compete intensely for market share with hardly any

cooperative activities among the groups As savings banks are owned by German

states towns or local authorities they are protected by law from takeovers by

institutes from the other banking sectors4 Due to the high fragmentation of the

German market hardly any bank has dominant market power The five largest

banks have a total market share of only 20 percent and new competitors enter the

market and attract customers with aggressive price differentiation offers5 The

strong competition among private banks savings banks and co-operative banks

results in low profit margins by international comparison The profit potential in

German private-customer business has fallen for many years From 2000 to 2006

total income from the financial service providers in Germany measured by the

distribution of financial products with private customers fell approximately 15

from euro 675 billion to euro 574 billion6 Though the retail banking sector has

experienced some increase in profits due to cost reduction and reduced loan

failures in 2007 market potential still stagnated in 20097

Since the financial crisis has raised the awareness of the threats of investment

banking many banks have refocused on core business activities in order to

maintain their solvency through increased account deposits Banks need money to

grant loans to private individuals or enterprises provide investment opportunities

finance consumer goods or simply realize baking transactions Yet the recent

financial crisis caused distrust among the banks and loans will not be granted as

1 Plickert (2009) 2 Deutsche Bank (2009) 3 Koumlhler and Lang (2008) 4 Spiegel Online (2007) 5 Welp (2009) 6 Zebrolfesschierenbeckaccosiates (2008) 7 McKinsey amp Company (2007) Zebrolfesschierenbeckaccosiates (2008)

2

easily as before On the consumer side the financial crisis has increased the

demand for secure money investments A survey of 230 highly ranked managers

from private savings and co-operative banks on the effects of the crisis on their

business indicates that banks have concentrated more intensively on business with

private customers both during and after the latest crisis Moreover customer

demand for certificates company shares or funds has fallen significantly while the

demand for standard retail banking products such as call money accounts or

account books has increased substantially8

In spite of its high competitiveness and low profit margins the German retail

banking market is still attractive for foreign banks Foreign MNBs are increasingly

able to penetrate the market for private individuals9 In particular they gain market

share through new products decreasing prices standardized processes and

innovative marketing whereas domestic banks have often relied on continued

customer loyalty10 Although foreign multinational banks in Germany have usually

concentrated on large domestic corporations engaged in international

transactions11 they now enter the market for private and small corporate clients as

well12- a trend that has been supported by the development of internet technology

and other new marketing - channel options

The distinctive characteristics of the German banking market raise several

questions concerning both entry mode and business model considerations of

multinational banks Should a multinational bank engage in cross-border lending or

rather enter the market via foreign direct investment How do the development of

economic political-legal and social-cultural factors in the German market affect a

multinational bank`s entry mode and business model choice

This thesis distinguishes between the non - equity entry modes of cross-border

lending and alliances as well as the equity entry modes of representative offices

branches subsidiaries and JVs both from a Greenfield investment and an

acquisition point of view Each of these organizational entry mode forms has

8 Welp (2009) 9 Reitz (2005) 10 McKinsey amp Company (2007) 11 Hersh and Weller (2002) 12 Koumlhler (2008)

3

distinctive advantages and disadvantages Hence the main focus of this thesis is to

provide a broad understanding of the distinctive market entry and penetration

strategies in light of macro and micro economical developments in Germany

11 Research Objective

This thesis examines entry mode choice decisions and business model

considerations of multinational banks entering the German retail banking sector

The objective is to evaluate the affect of current market developments on their

entry mode decisions

In light of the financial crisis and the banks` rediscovery of the private individual

the German banking sector is currently experiencing a renaissance resulting in

increasing industry rivalry At the same time the processing of bank transactions

and customer services is becoming increasingly independent of the branch

distribution channel and the adoption of new technologies is substantially affecting

the allocation of retail banking services13 The technological evolution is

exemplified by the emergence of web-based direct banks which have been able to

penetrate the retail banking market with low-cost structures innovative ideas and

distinctive service thinking

Eventually the growing importance of the internet and other technological means

as distribution channels on the one hand and the remaining strong demand for

personal consultation on the other hand require a customer-oriented multi-channel

management of the banks14

This paper contrasts the two opposing ends in the field of retail banking

distribution channels It simplifies the entry mode choice between direct banks that

solely operate through the internet and brick amp mortar banks which solely operate

through a branch network Furthermore it differentiates between branch entry via

Greenfield investment and subsidiary entry via acquisition

Two major questions will be addressed

13 Deloitte (2010) 14 Welp (2009)

4

Firstly to what extent do demographic and technical developments favor a direct

bank entry mode over a brick and mortar bank approach in Germany

Secondly what affects the decision in favor of a branch entry mode via Greenfield

investment as compared to a subsidiary entry mode via acquisition in Germany

12 Structure

This thesis is systematically divided into two different complexes - a theoretical

and a practical After a classification of essential banking terms in the section 2

Section 3 then describes relevant market entry theories ndash namely the Transaction

Costs Theory and the Eclectic Theory as well as market entry strategies ndash namely

the offensive and the defensive strategies of expansion

In section 4 the German retail banking market is analyzed within the five forces

framework The goal of this examination is to evaluate market attractiveness and to

identify micro and macroeconomic developments that may shape the market in the

future

Given the theoretical framework of section 3 and the knowledge of industry

structure and trends of section 4 section 5 explores the decision driving factors of

entry mode choice In this section cross-border lending alliances joint ventures

and representations will be discussed Furthermore this section indicates what

affects the decision in favor of a branch entry mode via Greenfield investment as

compared to a subsidiary entry mode via acquisition and to what extent

demographic and technical developments favors a direct bank entry mode over a

brick and mortar bank entry mode in Germany

Section 6 introduces the SWOT analysis as well as the Service Marketing Mix and

applies these concepts to the ING - DiBa case study It illustrates how ING- DiBa

penetrated the German retail banking market with both the implementation of the

direct banking business model and the exploitation of external opportunities

Finally this thesis concludes with a summary of the major findings

5

2 Classification of Banks

21 Bank

This paper refers to banks as defined in the German Banking Act Section 1 GBA

defines financial institutes as enterprises which pursue banking transactions

insofar as the extent of these transactions requires commercial business operations

At least one of the following transactions has to be carried out security

transactions credit transactions payments transactions or other banking business

The enterprise which pursues banking transactions in Germany requires the

permission of the BaFin (Federal Institution for Finance Service Supervision)

according to section 32 GBA

22 Direct Bank

Direct banks are credit institutes which operate without a branch network and

utilize the internet and the telephone as direct communication channels through

which banking transactions are realized and marketing and customer service takes

place Thus direct banks establish cost advantages which they usually transmit in

the form of attractive terms15

23 Brick and Mortar Bank

A brick and mortar (BampM) company is a traditional street-side business that

deals with its customers face to face in an office that the company owns or rents16

A brick and mortar bank serves consumers in a physical facility as distinct from

providing online or telephone services only The term brick and mortar is not a

generally valid classification of a bank but in the jargon of e-commerce it is

frequently employed to distinguish from internet based enterprises In this thesis

the term brick and mortar bank is employed to differentiate between a direct bank

that operates through direct channels and one which operates solely through its

branch network The term brick and mortar is also distinguished from the term

click and mortar which is an expression for a form of multi-channel retailing in

15 Deutsche Bundesbank (2010) 16 Investopedia Dictionary (2010)

6

which both electronic distribution channels (click) and physical premises (mortar)

are utilized17

24 Multinational Bank

Multinational banks are defined as banks that have a physical presence in more

than one country In contrast international banks engage in cross-border operations

but do not establish a physical presence in foreign countries18

25 Retail Bank

There is no generally valid classification of retail banking in theoretical literature

or in practice19 A distinction in retail banking is often made with regard to its

target clientele In this regard some authors define retail banking as the offering of

banking and financial services to individuals and small and medium sized

enterprises20 Other sources define retail banking as the provision of these services

solely to individuals21 This paper employs the following classification of retail

banks `A retail bank is a bank that caters for ordinary individuals and small

business as distinct from large corporations Retail banking operations offer

deposit facilities lend money transfer funds and are prepared to deal in relatively

small amounts`22 In contrast to private and corporate banking retail banking

considers private clients with low to average income as well as small corporate

clients

2

Figure 1 Classification of retail banking clients

(own illustration based on Swoboda 2004)

17 Gabler Wirtschaftslexikon (2010) 18 Hersh and Weller (2002) 19 Muumlller and Joumlhnk (2005) 20 Pond (2007) FinanceWiki (2008) Tremblay and Tremblay (2007) 21 Frei Harker and Hunter (1998) Online Businessdictionarycom (2010) Investoglossarycom (2010) 22 Essvale Corporation Limited (2007)

Retail Banking

Medium and large corporate clients

Wealthy private clients

Small Corporate clients

Private clients

7

3 Market Entry Theories and Strategies

31 Transaction Costs Theory

In the transaction cost theory developed by Ronald Coase and Oliver E

Williamson a comparison of transaction costs determines the optimal form of

organization In TC Theory the entry mode decision is a tradeoff between the

control and the costs of resource commitment Entry modes vary in three major

aspects the cost of resource commitment control as the level of ownership and

environmental risks that may affect the committed resources Hence high-control

modes increase both risk and the potential return23

Williamson differentiates between ex-ante and ex-post transaction costs

Information and searching costs are incurred ex-ante in the process of collecting

market information and identifying suitable partners Negotiation and contract

costs arise ex-ante due to negotiations legal advisory and the determination of

contractual terms Monitoring costs develop ex-post for activities which serve to

control contractual obligations Conflict and enforcement costs arise ex-post due to

the different interpretation of the contract and the costs of enforcing contractual

regulations with sanctions negotiations or through court proceedings Adaption

costs are incurred due to ex-post changes in contractual agreements that become

necessary because of unpredictable developments24

TCE assumes the existence of bounded rationality and opportunism Bounded

rationality describes the limitation in human processing of information and the

planning of possible outcomes Opportunism describes the notion that humans may

act in a self-interested manner by manipulating information and being dishonest

The consequences of these assumptions are incomplete contracts and moral

hazards25 Vice versa opportunism occurs because firms can not write complete

contracts

The size of the transaction costs is determined in each case by the characteristics of

asset specificity uncertainty and frequency Asset specificity arises when the actor

in the market undertakes specific investments in order to fulfill his contractual 23 Chen and Mujtaba (2007) p322 24 Kieser and Ebers (2006) p278 25 Magill and Quenzii (1996) p11

8

obligations It refers to the degree to which long-lasting human or physical assets

are bound in a specific relationship and thus to the extent to which they provide

value in the context of a different situation26 In TCE markets can hardly solve the

problems that high uncertainty creates in combination with bounded rationality and

threats of opportunism Uncertainty includes environmental and behavioral

uncertainty Environmental uncertainty refers to political legal cultural and

economic uncertainties that may affect the success of business transactions

Behavioral uncertainty states that bounded rationality and the threat of opportunism

result in the high costs of monitoring a partner company27 If the similar

transactions are repeated frequently learning effects and economies of scale occur

and will reduce the transaction costs

32 Eclectic Theory

The eclectic theory28 (or OLI paradigm) was developed by John Dunning and is a

framework that merges different economic theories which explain foreign market

entry patterns of multinational corporations29 It states that the internationalization

of MNCs is determined by three sets of independent variables ownership

advantages (or firm- specific advantages) location advantages (or country specific

advantages) and internationalization advantages

The ownership advantage considers the competitive advantages of MNCs arising

from firm-specific characteristics such as size monopoly power economies of

scale management brand name technology and other resource capabilities30

These advantages are usually intangible assets and can be transferred at low costs31

The greater the competitive advantage of the MNC is the more likely it is able to

start or to increase its foreign production32

The location advantages arise from country specific benefits that can be divided

into three categories Firstly a host country may have economic advantages

comprising qualitative and quantitative factors such as production transports costs

26 Dietrich (1994) p18 27 Brouthers and Brouthers (2003) p1183 - 1185 28 Dunning (1980) Dunning (1988) Hill Kwang and Kim (1990) 29 Dunning (2002) 30 Forsbaeck and Oxelheim (2004) 31 Griffin and Pustay (2006) 32 Dunning (2002)

9

communication costs market size or tax incentives Secondly a host country may

offer political advantages in particular governmental policies that may influence

market entry Thirdly a host country may provide social and cultural advantages

including the psychic distance between the foreign and the domestic country as

well as language or cultural aspects that may have an impact on the market entry

decision The higher the attractions of the specific location the more likely it is that

MNCs will exploit their ownership advantage by entering the foreign market33

Because of the existence of transactions costs the internationalization incentive

advantage states that it must be profitable for the MNC to exploit these advantages

itself rather than through local companies (eg licensing)34

In economic literature the OLI paradigm has also been applied to the banking

sector In this regard ownership advantage may include easy access to a vehicle

currency Locational advantages may include country-specific regulations and

entry barriers Internationalization advantages can be information advantages and

access to local deposit bases35

Many empirical studies on the banking market have utilized the eclectic paradigm

as a basic framework For example a study of bank entry into CEE markets

concludes that the ownership advantages of foreign MNBs are strong compared to

banks in emerging markets and especially when the foreign country experiences a

banking crisis36 An application of the OLI paradigm to the Spanish banking

market has shown that bank size and multinational experience of MNBs favor

stronger commitment in the foreign country whereas distance is an entry barrier37

However theoretical literature also states that in service industries clients close to

the MNBs headquarters may be served from this location whereas clients in distant

markets require a physical presence of the MNB in the foreign country which

favors a foreign market entry with increasing distance38

33 Dunning (2002) 34 Hagen (1997) 35 Yannopoulus (1983) 36 Uiboupin and Sorg (2006) 37 Blandoacuten (1998) 38 Blondoacuten (1998) Terpstra and Yu (1988)

10

33 Strategy of Defensive Expansion

A common approach employed to explain the expansion of MNBs involves the

theory of defensive expansion which is also referred to as the acutefollow-the-

customeracute argument

This theory states that MNBs expand abroad in order to provide services for

domestic clients which are often large enterprises that have entered a foreign

market39 The provision of financial services in the foreign country usually requires

a presence at important economic centres Hence to some degree expanding

corporations impose pressure on their domestic banks to follow-up40

The term acutedefensiveacute is derived from the idea that a failure to expand may lead to a

loss of the client not only in the foreign country but also in the domestic one as

the client may associate with a foreign MNB41 Consequently MNBs which pursue

this strategy seek to prevent losses rather then to generate new profits in the foreign

market42 Furthermore the domestic bank has an incomparable competitive

advantage over banks in the foreign country with regard to the knowledge of

customer needs the respective risk of credit default as well as an interest in cross-

selling products such as financial advisory43

Due to earlier business relationships with the client the domestic bank has reduced

costs for examining the financial capacities of the respective enterprise and thus

can offer cheaper services44 Most foreign entry evidence supports the defensive

expansion theory45

A study on this theory with respect to retail banking has revealed that MNBs

sometimes expand abroad in order to provide banking services to specific

communities46

39 Trend im retail-banking koumlhler 40 Henneberger and Graf (2000) 41 Mullineux and Murinde (2003) 42 Naaborg (2007) 43 Knoop (2006) 44 Bhattacharya (1994) 45 Bhattacharya (1994) Naaborg (2007) 46 Tschoegl (1987)

11

34 Strategy of Offensive Expansion

MNBs that offensively expand abroad primarily seek to increase their customer

base both in the home and in the foreign country Firstly the establishment of

foreign branches and subsidiaries enables the MNB to expand their services to

domestic residents who benefit from the international orientation of the bank

These may include customers that have business partners in the foreign country

Secondly MNBs may target new customers in the foreign country in particular

MNEs or foreign subsidiaries of domestic enterprises As the MNB must in both

cases entice customers away from other banks the MNB has to offer attractive and

competitive conditions for their financial services47

47 Buumlschgen (1998) p604

12

4 Industry Analysis German Retail Banking Sector

41 Porter`s Five Forces

In the school of Industrial Economics the five-forces model has established itself

as a core element of industry analysis Porter`s analysis framework is built on the

following five market forces that shape the strategy of competitors threat of new

entrants threat of substitute products or services bargaining power of buyers and

suppliers as well as rivalry among existing competitors

Porterrsquos concept is based on the knowledge that the strategy of an enterprise must

orient itself to its market environment whereby the competitive strategy arises

from a differentiated understanding of the market structure and the knowledge of

how it changes The effects of these forces determine the intensity of the

competition in a market and with it its profitability and attractiveness Therefore

the aim of the enterprise strategy should be reflected in the search for possibilities

for the reduction or use of these competitive forces relative to its own enterprise In

this regard Porter`s model is conducive to the analysis of the driving forces

working in the respective industry

Figure 2 Michael E Porter`s five forces model (Own illustration based on Porter 1979)

Industry Rivalry

Threat of New

Entrants

Bargaining Power of

Buyers

Threat of Substitute Products

and Services

Bargaining Power of Suppliers

13

Porter`s framework is a useful and frequently utilized analytical tool to describe the

foundations of industry competition

A high degree of rivalry among the existing enterprises leads to high competitive

pressure and can lower profit margins and the profitability of individual

enterprises In situations in which a large number of enterprises target similar

market segments with comparable strategies in which the market grows slowly

price is the most important differentiation factor and high exit barriers exist a

negative impact on the industryrsquos profitability is effected48

The threat of new entrants can be determined by the entry barriers of a market The

competitive pressure on existing enterprises increases with low entry barriers In

such a situation important elements of the market (eg shares of the market price

level) can change due to the entry of new market participants49

The bargaining power of buyers determines to what extent customers can influence

enterprises by the amount of consumption and the pressure on margins Important

indexes of a high degree of buyer power include high fixed costs in the industry

existence of supplements of the product or service high degree of customer

concentration customers` knowledge of production costs possibility of a reverse

integration of customers high growth rates of the market and a strong

individualization of customer demand50

The bargaining power of suppliers affects industry profitability if for example a

concentrated supplier group dominates over existing enterprises in the market

which are not important buyers for the suppliers Then the industry faces high

margin pressure by the suppliers

A threat of substitute products and services exists in particular if cheaper or higher-

quality products and services are able to reduce existing sales volumes of a market

or an enterprise51 The future sales potential of existing enterprises becomes limited

and industry competition increases

48 Porter (1985) 49 Porter (1979) Recklies (2001) 50 Recklies (2001) 51 Recklies (2001)

14

Critics of this model state that it neglects the impact of complements as a sixth

force of the industry since they may facilitate or hinder the commercialization of

certain goods However Porter argues that complements are not a force itself but

they affect profitability in the way that they influence the five forces and that `the

strategist must trace the positive or negative influence of complements on all five

forces to ascertain their impact on profitability`52

One limitation of this model is based on studies which indicate that company-

specific factors may have a more important impact on profit than industry forces53

Furthermore the model suggests relatively static and stable market structure which

makes it difficult to assess contemporary dynamic markets54

The model does not assess the impact of the parent company on its subsidiary

which is especially important in the banking sector in which parent companies

often have a strong impact on the performance of their subsidiary or branch The

parenting advantage includes the stand-alone influence through monitoring and

influence on management decisions or capital expenses Furthermore parents

create value by enhancing synergies within the group offering corporate functions

or managing portfolios55

42 Rivalry among existing competitors

In this section the intensity of competitive rivalry among existing competitors in

the German retail banking sector is discussed In this regard an analysis of industry

structure industry growth and exit barriers will be conducted

Industry structure The German banking market is characterized by a three-pillar

system which is reflected by the strict distinction between public-law banks

cooperative banks and private banks56 Each pursues different goals and is subject

to different regulations Private commercial banks pursue the goal of profit

maximization whereas saving banks serve the public contract of offering secure

52 Porter (1997)p11 53 Zack (1999) 54 Recklies (2001) 55 Goold Cambpell and Alexander (1994) 56 Gramlich (2005)

saving possibilities and loans C

interest of their members

banking market is structured as follow

Figure 3(own illustration based on Sch

Public-law banks including saving banks and state banks

total balance sheet volume of banks in Germany

do not participate in retail banking The cooperative bank sector amounts to 11

the total including cooperative banks

cooperative central banks

commercial banks including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

31 of total balance sheet volume

European Research (ZWE) 43 of experts state that the three

important or very important and

for the low number of cross

In order to describe industry rivalry among maj

retail sector the following table illustrates the number of customers per bank in

Germany

57 Engerer (2006) 58 Koumlhler (2008b)

banks 24

Private commercial banks 31

15

possibilities and loans Cooperative banks primarily serve the economic

interest of their members57 In terms of total balance sheet volume the German

banking market is structured as follows

Figure 3 Structure of the German Banking Sector(own illustration based on Schrooten 2009)

law banks including saving banks and state banks amount to 33 of the

total balance sheet volume of banks in Germany However state banks

do not participate in retail banking The cooperative bank sector amounts to 11

including cooperative banks which participate in retail ban

cooperative central banks which primarily serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

alance sheet volume According to a recent survey of the Center for

European Research (ZWE) 43 of experts state that the three-pillar system is

important or very important and 33 state that it is the critical factor responsible

cross-border mergers and acquisitions in Germany

In order to describe industry rivalry among major banks that participate in the

the following table illustrates the number of customers per bank in

Savings banks 13

State banks 20

Cooperative central banks

3Credit cooperative banks 8

Other banks 24

serve the economic

sheet volume the German

Structure of the German Banking Sector

amount to 33 of the

However state banks generally

do not participate in retail banking The cooperative bank sector amounts to 11 of

participate in retail banking and

serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks amount to

According to a recent survey of the Center for

pillar system is

33 state that it is the critical factor responsible

border mergers and acquisitions in Germany58

or banks that participate in the

the following table illustrates the number of customers per bank in

State banks 20

Cooperative central banks

16

Figure 4 Customers of German Banks at the end of 2007 in millions (own illustration based on Deutsche Bank 2008)

With approximately 50 million customers savings banks are the market leader in

the German retail banking sector Although state liability assumption for savings

banks was abolished in 2005 because the EU saw in it an unacceptable subsidy to

the disadvantage of private banks customers still associate the name `Sparkasse`

with state guarantees The specific characteristic of a saving bank is based on its

public contract in that it has to accept customers with poor credit-worthiness that

profits should be used to enhance public wealth and that the middle class should be

supplied with loans59

With approximately 30 million customers cooperative banks are the second major

player in the German retail banking sector Nearly half of these customers are

members of the cooperative banks60 In contrast to the profit maximization goal of

private commercial banks their aim is to fund their members and secure their

economic independence Although cooperative banks are economically and legally

independent in the different regions they appear uniformly as a group under the

brand of ldquoVolks- und Raiffeisenbankenrdquo With regard to growth in customer base

cooperative banks benefit from the advantage of having the regional flexibility that

59 Kruck (2008) 60 Online Raiffeisen Bank Homepage

31

4

61

118

242

30

50

0 10 20 30 40 50 60

Citibank

Hypovereinsbank

ING DiBa

Commerzbank and Dresdner Bank

Postbank and Deutsche Bank

Credit Unions (Volksbanken)

Savings Banks (Sparkassen)

17

allows for topical advertisement as well as a centralized management focus on

improving reputation61

The third group comprises the major private commercial banks including Deutsche

Bank Postbank Commerzbank and Hypovereinsbank Deutsche Bank is a leading

multinational investment bank but with relatively low market share in the retail

banking market Deutsche Bank (97 million clients) is acquiring Postbank (145

million clients) with its broad branch network in a three-step process Together

they have 242 million clients However Heino Ruland from the analyst company

Frankfurt Finanz Partner argues that Deutsche Bank might not be able to capitalize

on the financially weaker Postbank clients as Deutsche Bank is specialized in

corporate clients62 With regard to rivalry intensity and market profitability Rainer

Neske supervisory board member and head of private amp business clients of

Deutsche Bank emphasizes that the German retail banking market is too

fragmented to be highly profitable and that Deutsche Bank does not seek to

compete on the price level but defines itself through performance quality and

consultancy63

Commerzbank is the second largest private commercial bank in Germany After the

acquisition of Dresdner Bank in 2009 Commerzbank now serves more than 12

million clients (of these 11 million private and one million corporate clients) and

pursues the goal of becoming the market leader in Germany64

UniCredit Bank AG with the brand name Hypovereinsbank (HVB) is a subsidiary

of UniCredirSpA and is the third largest private commercial bank in Germany

HVB serves approximately four million clients predominantly in north Germany

and in Bavaria As its retail banking segment could only report marginal profits in

2009 speculation about a sale or acquisition in this segment has come up As the

Swedish SEB (Skandinaviska Enskilda Bank) is considering selling its German

retail segment with 174 branches and one million clients experts now regard HVB

as a major buying candidate65

61 Schwarzbauer (2009) 62 Kreiler (2008) 63 Deutsche Bank (2009) 64 Kreiler (2008) 65 Houmlpner and Nagl (2010)

18

ING DiBa AG is a subsidiary of the Dutch ING Group and serves over 6 million

clients In contrast to savings cooperative and the major private commercial

banks ING DiBa is specialized in direct banking which distributes services via

telephone the internet or post instead of through branches In Germany ING

DiBa is the leader in direct banking but there are many other direct banks such

as Comdirect (a subsidiary of Commerzbank) Volkswagen Bank or DAB Bank

(a subsidiary of HVB) Competition takes place not only among direct banks but

also between direct and branch banks For instance many saving banks have

blocked the opportunity for customers of direct banks to withdraw cash from their

automated teller machines As savings banks can only charge Euro 174 for

withdrawals via visa cards they fear that direct banks can gain market share by

offering attractive account options with a convenient wide-area ATM provision66

Targobank (former Citibank Deutschland) was acquired by the French

cooperative bank Creacutedit Mutel and now serves more than 34 million clients in

Germany in 2010 The bank is specialized in private retail customers with

branches and direct banking67

In conclusion the degree of concentration in the German retail banking market is

very low which reduces the overall profitability of this sector for two main

reasons Banks earn higher profits in concentrated markets as they obtain either

monopoly rents (structure-conduct-performance paradigm) or due to high market

shares that are gained by more efficient and profitable banks (efficient structure

hypothesis)68 As retail banking services are largely standardized product

differentiation is low and price differentiation is often the only option As public-

law banks serve other interests than profit maximization existing private banks

and MNBs that want to enter this market have a competitive disadvantage The

low switching costs of clients intensifies competition on the price level and thus

reduces the profitability of the market However brand identification and

customer relationships are also important which decreases the willingness of

clients to switch solely on the basis of price comparison In summary market

structure indicates a very high degree of rivalry among existing competitors

66 Online Financial Times Deutschland (2010) 67 Targobank (2010) 68 Havrylchyk and Jurzyk (2006) p15

19

Industry growth In this section industry growth will be examined in a dynamic

analysis of three relevant market growth indicators the future long-run

development of the German population the historical development of the number

of banks and branches in Germany and the historical development of market-

share allocation in the context of major retail banking activities

In the long-run market growth depends on the future numerical development of

the market`s customers - the German population As the growth of population

through birth and immigration is smaller than its decrease by virtue of the mortality

rate and emigration the Federal Statistical Office in Germany estimates a sharp

decline of the German population

Figure 5 Estimated Development of German Population (in millions)

(Federal Statistical Office 2009)

The Federal Statistical Office predicts that the trend of decline in population since

2003 will continue and intensify Whereas approximately 82 million people lived

in Germany in 2008 only between 65 million (average lower limit of the

population with 100000 immigrants yearly) and 70 million people (average

upper limit of the population with 200000 immigrants yearly) will reside in

Germany in 2060 Furthermore the decreasing number of births and the ageing of

the current strongly represented middle age group will lead to substantial changes

in the age structure of the population From 2008 to 2060 the proportion of people

from 65 to 80 years will increase 15 to 20 and the proportion of people over

80 years of age will increase from 5 to 14 of the population69 The

69 Federal Statistical Office (2009)

Average lower limit

Average upper limit

20

implications of the aging population for banks will be discussed in the comparison

between direct banks and BampM banks in section 66 of this thesis

The second indicator of industry growth deals with the number of banks and bank

branches in the German market The overall number of banks in Germany

decreased from 3785 in 1995 to 2300 in 2006 As retail banking usually depends

on the number branches maintained their development in Germany will be

examined

Figure 6 Development of Total Bank Branches in Germany (own illustration based on Koumlhler2008a)

Savings banks and cooperative banks have reduced the number of branches

significantly Public-sector banks (savings banks state banks etc) with 18757

branches and cooperative banks with 16028 branches in 1998 reduced the

number of branches to 14252 and 12303 respectively in 2006 Moreover the

number of branches of major commercial banks decreased from 19055 in 1998 to

8879 in 2006

The main cause for the decrease of branches is the high fixed costs which can not

be recouped from low-revenue standard products that can also be distributed

through alternative low-cost channels such as the internet70

70 Koumlhler and Land (2008)

67930 6666363186

59929 58546 5693653931

5086847244 45467 44100

40332

0

10000

20000

30000

40000

50000

60000

70000

80000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

21

As a third indicator of industry growth this paper reflects on the allocation of

market share within the retail banking sector in order to indentify trends that may

affect overall market growth This paper will reflect on market share in two major

retail banking segments - savings deposits and loans The German Central Bank

classifies the banking market in terms of savings banks cooperative banks direct

banks and credit banks The latter include universal banks which are private

commercial banks branches of foreign banks regional banks and other private

banks

This section reflects the development of market share regarding short- medium-

and long-term saving accounts and examines the allocation of loans to corporate

clients consumers (consumer loans) private households and self-employed

persons

In the period from 1998 to 2006 the market for medium-term saving deposits with

a cancellation period under three months has been dominated by saving banks (53

market share in 2006) and cooperative banks (29 market share in 2006) In the

same period the market share for long-term saving deposits with a cancellation

period above three months has also continuously been dominated by savings banks

(65 market share in 2006) and cooperative banks (24 market share in 2006)

However with regard to deposits that mature daily direct banks were able to

increase market share from approximately 15 in 1998 to over 15 in 2006

Figure 7 Market share development of saving accounts that mature daily (own illustration based on Deutsche Bundesbank 2007)

000

500

1000

1500

2000

2500

3000

3500

4000

4500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Banks

Cooperative Banks

Savings Banks

Credit Banks

22

From 1998 to 2006 market share for loans for corporate clients has been

continuously dominated by credit banks (53 market share in 2006) and savings

banks (34 market share in 2006) However this data also comprises loans for

medium and large corporations which are not part of the retail banking market

Loans for private households and self-employed persons have predominately been

granted by savings banks (39 market share in 2006) credit banks (30 market

share in 2006) and cooperative banks (25 market share in 2006) though direct

banks were able to gain some market share from 0 in 1998 up to 5 in 2006

Even more significantly direct banks were able to gain over 16 market share in

the segment of consumer loans

Figure 8 Market share development of consumer loans (own illustration based on Deutsche Bundesbank 2007)

Hence the most significant growth indicator of the retail banking market results

from the emergence of direct banks which were able to gain substantial market

share in consumper loans and deposits that mature daily

In conclusion the industry growth analysis indentifies the following growth

indicators Firstly a sharp decrease in the German population in the following

decades will reduce growth and increase industry rivalry Moreover the

demographic change increases the proportion of old people in the population

Secondly the number of branches in Germany is decreasing due to high fixed

costs of branches In order to be profitable in retail banking the existing branches

must serve a large quantity of customers which leads to strong competition

relative to market share Thirdly the development of market share allocation

000

1000

2000

3000

4000

5000

6000

7000

2002 2003 2004 2005 2006

Savings Banks

Cooperative Banks

Direct Banks

Credit Banks

23

indicates that only direct banks have experienced significant growth from 1995 to

2006

Exit barriers From a perspective of Transaction Costs Economics one can argue

that exit barriers in branch banking are high for market participants as branches

and staff are highly specific assets that lose value when used in another situation

To a large extent these assets are locked into the context of retail banking

Moreover public-law banks usually have to serve the population regardless of

whether they are profitable or not In a situation in which a bank continuously

experiences losses staff and branches may be considered as sunk costs and thus

economically `irrationalacute exit barriers However theories suggest that staff and

branches are practically valid exit barriers and cause MNCs to stay in a market71

The high degree of exit barriers intensifies the strong rivalry among existing

competitors

43 Threat of New Entrants

New entrants usually seek to gain market share while applying pressure on prices

and costs and thus increasing the investments necessary to compete An expert

survey conducted by the ZEW emphasizes the importance of entry threat to the

German retail-banking market 6666 of market experts state that new

competitors (eg foreign banks) have an important or a very important impact on

industry rivalry72

In this section the threat of new entrants to existing market participants in the

German retail banking sector is discussed In this regard this section evaluates

legal entry barriers capital requirements the necessity of large scale operations

customer switching costs and incumbency advantages of existing domestic banks

Legal entry barriers are determined by governmental regulations in the German

Banking Act (GBA) and are supervised by the Federal Supervisory Authority73

According to section 32 para 1 (1) GBA companies that intend to pursue

commercial banking transactions or financial services in Germany require written

71 Hill Hwang and Kim (1990) 72 Koumlhler and Lang (2008) 73 Bundesanstalt fuumlr Finanzdienstleistungsaufsicht (2005)

24

permission from the Federal Financial Supervisory Authority ( ldquoBundesanstalt fuumlr

Finanzdienstleistungaufsichtrdquo) The execution of banking transactions or financial

services also exists when the operator has its headquarters or primary residence

abroad but repeatedly targets companies or individuals who have their primary

residence in Germany In order to obtain the permit several requirements are

examined (eg business plan qualified management etc)

Companies from third countries which intend to conduct banking transactions and

provide financial services in Germany must establish a subsidiary (section 32 para

1 in connection with ection 33 para 1 (6) GBA) or a branch (section 32 para 1 in

connection with section 53 GBA) in Germany Companies from third countries can

apply for an exemption according to section 2 para 4 GBA if the company is

supervised utilizing international accounting standards in the home country and the

responsible authority works together with the BaFin According to section 53b

GBA companies of EEA states are allowed to establish branches (section 53b para

2) but are also free to conduct cross-border financial services without a domestic

presence (section 53b para 2a) Section 32 para 1 GBA does not apply to business

that is motivated by the initiative of the domestic individual or enterprise (so called

passive service freedom)

Representations are limited to their representative function and are not allowed to

conduct or initiate any banking business

Capital requirements are low for cross-border lending and and relatively low for

representations With high equity modes such as branches and even more so with

subsidiaries capital requirements are relatively high as capital is required for

building a broad network of facilities and offering credit to customers Capital

requirements for direct banks are relatively low compared with those of BampM

banks

The necessity of large scale operation is related to the competitive advantage of

economies of scale A company that serves the market in the context of larger

quantities benefits from lower cost per unit In retail banking profit is gained by

having a large number of clients It is expensive to build up these numbers and to

establish a distribution network to serve them This necessity relates directly to the

strategy of the bank An acquisition offers a shortcut to these facilities although the

25

costs of integration can be high as well74 A MNB may also decide to target only a

certain geographical area with certain clients and therefore do not have to enter on

a very large scale

Customer switching costs are different for each individual In general customers

can easily change their banks and open a deposit account or apply for a loan at

another bank However they have to compare the different terms for usually small

transactions to evaluate the convenience of having a bank nearby and then to

decide to terminate the relationships with their current bank75

Finally the incumbency advantages of existing banks are important entry barriers

In particular they include established brand reputation possession of the most

favorable geographical locations and market knowledge Moreover established

banks may already have exclusive contracts with SMEs76

To conclude legal entry barriers are low and particularly low for banks from the

EEA Capital requirements for entering the market are high yet as far as equity

entry modes are concerned direct banks require relatively low capital as they

distribute their services through low-cost channels Banks need to attract many

customers to be profitable but banks strategy dictates whether or not to entrance

should occur on a large scale Moreover the incumbency advantages of existing

banks constitute important entry barriers

44 Threat of Substitute Products or Services

A substitute in retail banking is a service that offers an attractive trade-off to a bank

service or product As individuals and small firms do not regularly report financial

information as do large enterprises they rely primarily on bank lending However

there are additional forms of financing in the private equity or dept market77

Many non- and near- banks provide substitute products and services Near-banks or

quasi-banks are suppliers of financial services but are not classified as credit

institutes according to section 1 GBA Near-banks such as insurance companies or

credit card organizations however do provide substitute products or services Non-

74 Hughes and MacDonald (2009) 75 Adams (2002) 76 Adams (2002) 77 Xiaoqin and Terada-Hagiwara (2003)

26

banks such as department store chains catalog companies or car producers also

provide substitute services78 For instance instead of taking out a loan in order to

pay for a product individuals or small enterprises may decide to take on a leasing

contract for a certain asset or small enterprises can obtain a trade credit as well

Individuals may decide on buying products from insurance companies instead of

putting money into a bank account

Another substitute for both direct and BampM banks is the person-to-person (p2p)

lending business a new form of borrowing and lending money that takes place in a

web-based market place In this online platform borrowers are connected to

lenders through an auction-like process in which a lender who bids to provide a

loan for the lowest interest rate will be awarded the loan contract with the

borrower A p2p company mediates between private or company borrowers and

lenders and also executes transactions between the parties similar to the role which

e-bay plays in the trade of commercial goods79 The p2p lending business does not

involve traditional banks and thus can offer superior interest rates to borrowers and

higher returns for lenders

45 Bargaining Power of Suppliers

When a supplier group is more concentrated than the industry does not primarily

depend on the industry and when the industry faces high switching costs the

supplier group has strong bargaining power and can reduce the profit potential of

an industry In the retail banking market the most relevant suppliers include human

resources suppliers of capital resources and suppliers of information and

communication technology (ICT)80 Highly talented or experienced specialists are

strongly canvassed and have strong bargaining power with respect to their salary

and working conditions However in the aftermath of the financial crisis many

banks are planning a reduction of staff According to a study of Ernst amp Young

every fifth bank intends to decrease staff and only every 10th bank is planning an

increase81 Given the current situation of the employment market the bargaining

power of employees is relatively low Suppliers of highly specialized banking ICT

78 Gabler Wirtschaftslexikon (2010) 79 Deloitte (2009) p 12 80 Buumlschgen and Boumlrner (2003) 81 Ernst amp Young (2009)

27

solutions have strong bargaining power as switching costs for these systems are

very high Moreover the higher yield requirements of shareholders can be

interpreted as supplier power

46 Bargaining Power of Buyers

In retail banking there are many buyers with relatively low transaction volumes

which weakens their bargaining power However retail banking services are

standardized and buyers can easily find similar services Switching costs have

usually been relatively high for these low volume transactions but in the age of the

internet the market is very transparent and buyers can screen different offerings

more easily This does not necessarily imply that the cheapest banking service will

be chosen automatically as customers also seek a trustworthy brand especially in

times of financial crisis Moreover there are other factors that affect the switching

cost of the individual such as the location of the branch Yet there is a tendency

towards the increasing bargaining power of buyers

This is also substantiated by the ZEW survey 7984 of market experts state that

decreasing customer loyalty and increasing price sensibility are important or very

important factors with respect to the intensity of competition in the German retail

banking sector A comparison of former and modern retail customers also indicates

that the bargaining power of retail banking service users has increased

Former Retail Customer Modern Retail Customer

Passive information seeking

behavior

Active information seeking behavior

Hardy or little informed Good to very good know-how

High customer loyality Increasing willingness to switch

Fixation on the branch Expects multi-channel banking at all times

and places

Little market transparency High price transparency

Relatively undemanding Demanding

Figure 9 Comparison of former and modern retail customers (own illustration based on Swoboda 2004)

28

5 Foreign Bank Entry Strategies in Germany

This section illustrates mode choices for foreign bank entry in Germany Based on

the hierarchical model of market entry modes82 the foreign bank has the choice of

equity and non ndash equity modes of entry An advantage of the hierarchical model is

that it allows comparing between entry modes on different levels The main

difference between equity and non ndash equity modes is the degree of resource

commitment in the foreign country As classified at the beginning of this thesis

non-equity entry refers to international banking and equity entry refers to

multinational banking

The research question of this thesis considers multinational bank entry modes

International banking however is often a first step towards multinational banking

Hence this thesis will also discuss cross-border lending and alliances as non ndash

equity entry modes The following figure illustrates a comprehensive view of

market entry modes for banks

Figure 10 A hierarchical model of entry mode choices for banks (own illustration based on Pan and Tse 2000)

82 Pan and Tse (2000)

Entry Mode Choices

Non - Equity Modes

Export

Cross Border Lending

Contractual Agreements

Alliances

Equity Modes

Equity Joint Ventures

Greenfield Investment

Branch

Subsidiary

Representation

Acquisition

Subsidiary

Branch

29

The hierarchical model illustrates the various entry mode choices for entering the

German retail banking market The creation of a common European financial

market in which banks can integrate freely is a major goal of the European Union83

The previous section of this paper indicates that entry barriers are relatively low

and that the German market is highly competitive Hence the choice of a proper

entry mode which is appropriate to the capabilities and the strategy of the bank is

even more significant Therefore the following section will reflect on the strategic

concept governing the choice of entry modes as well as the proliferation of these

entry modes in the German retail banking market

An international bank that is not interested in investing equity in the foreign

market can enter by means of cross-border lending or by forming a non-equity

alliance These non-equity entry modes can help the bank to access niche markets

or to exploit locational advantages when the bank is located near the German

border

However a retail bank defined in the beginning of this paper as a bank that

`caters for ordinary individuals and small businessacute and that seeks to enter the

German market in order to gain significant revenue from deposits and loan

business might have to consider a physical presence in the foreign country

The analysis considers entry modes that are perceived as international banking

cross-border lending and non-equity strategic alliances Furthermore the equity

modes JVs and representations will be discussed

Subsequently this section compares the market entry of a branch through

Greenfield investment with the market entry of a subsidiary by virtue of

acquisition as these modes of entry are the most common in the German retail

banking market

Finally the following question will be addressed to what extent do demographic

and technical trends favor a direct bank entry mode over a brick and mortar bank

approach in Germany

83 Fidrmuc and Hainz (2008)

30

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks (own illustration)

51 Non ndash equity modes Export ndash Cross-Border Lending

Cross-border lending is equivalent to the export entry mode and is a simple non-

equity strategy to enter a foreign market A bank which participates in cross-

border lending must assess the creditworthiness of the individual borrower as well

as the country risk which involves the possibility that these loans will be impaired

by economic or political proceedings in the foreign country84 The country risk in

Germany is rather low as it is perceived to have a solid political and economic

situation (Country Rating A2) with a stable and a very efficient business

environment (Country Rating A1)85 As a bank will only have limited access to soft

information about the creditworthiness of the borrower the availability of loans

usually decreases and the interest on loans usually increases with distance86 Soft

information for private loans includes the previous experience with the account

management of the credit user environmental facts and a judgment relative to his

employment contract87 For corporate loans soft facts may include the market

environment corporate structure management a business plan as well as

84 Hughes and McDonald (2003) 85 Online wwwtrade-safelycom (2009) 86 Agrawal and Hauswald (2007) 87 Dizil (2009)

Entry Mode Choices of MNBs

Greenfield Investment

Branch

Brick and Mortar Bank Direct Bank

Acquisition

Subsidiary

Brick and Mortar Bank Direct Bank

1 Introduction

In the aftermath of the recent financial crisis1 and in times in which banks

rediscover the private individual ndash also described as the renaissance of retail

banking2 - significant attention is now being paid to the market entries of foreign

multinational banks3

The German retail banking market is highly competitive Private cooperative and

state-controlled savings banks compete intensely for market share with hardly any

cooperative activities among the groups As savings banks are owned by German

states towns or local authorities they are protected by law from takeovers by

institutes from the other banking sectors4 Due to the high fragmentation of the

German market hardly any bank has dominant market power The five largest

banks have a total market share of only 20 percent and new competitors enter the

market and attract customers with aggressive price differentiation offers5 The

strong competition among private banks savings banks and co-operative banks

results in low profit margins by international comparison The profit potential in

German private-customer business has fallen for many years From 2000 to 2006

total income from the financial service providers in Germany measured by the

distribution of financial products with private customers fell approximately 15

from euro 675 billion to euro 574 billion6 Though the retail banking sector has

experienced some increase in profits due to cost reduction and reduced loan

failures in 2007 market potential still stagnated in 20097

Since the financial crisis has raised the awareness of the threats of investment

banking many banks have refocused on core business activities in order to

maintain their solvency through increased account deposits Banks need money to

grant loans to private individuals or enterprises provide investment opportunities

finance consumer goods or simply realize baking transactions Yet the recent

financial crisis caused distrust among the banks and loans will not be granted as

1 Plickert (2009) 2 Deutsche Bank (2009) 3 Koumlhler and Lang (2008) 4 Spiegel Online (2007) 5 Welp (2009) 6 Zebrolfesschierenbeckaccosiates (2008) 7 McKinsey amp Company (2007) Zebrolfesschierenbeckaccosiates (2008)

2

easily as before On the consumer side the financial crisis has increased the

demand for secure money investments A survey of 230 highly ranked managers

from private savings and co-operative banks on the effects of the crisis on their

business indicates that banks have concentrated more intensively on business with

private customers both during and after the latest crisis Moreover customer

demand for certificates company shares or funds has fallen significantly while the

demand for standard retail banking products such as call money accounts or

account books has increased substantially8

In spite of its high competitiveness and low profit margins the German retail

banking market is still attractive for foreign banks Foreign MNBs are increasingly

able to penetrate the market for private individuals9 In particular they gain market

share through new products decreasing prices standardized processes and

innovative marketing whereas domestic banks have often relied on continued

customer loyalty10 Although foreign multinational banks in Germany have usually

concentrated on large domestic corporations engaged in international

transactions11 they now enter the market for private and small corporate clients as

well12- a trend that has been supported by the development of internet technology

and other new marketing - channel options

The distinctive characteristics of the German banking market raise several

questions concerning both entry mode and business model considerations of

multinational banks Should a multinational bank engage in cross-border lending or

rather enter the market via foreign direct investment How do the development of

economic political-legal and social-cultural factors in the German market affect a

multinational bank`s entry mode and business model choice

This thesis distinguishes between the non - equity entry modes of cross-border

lending and alliances as well as the equity entry modes of representative offices

branches subsidiaries and JVs both from a Greenfield investment and an

acquisition point of view Each of these organizational entry mode forms has

8 Welp (2009) 9 Reitz (2005) 10 McKinsey amp Company (2007) 11 Hersh and Weller (2002) 12 Koumlhler (2008)

3

distinctive advantages and disadvantages Hence the main focus of this thesis is to

provide a broad understanding of the distinctive market entry and penetration

strategies in light of macro and micro economical developments in Germany

11 Research Objective

This thesis examines entry mode choice decisions and business model

considerations of multinational banks entering the German retail banking sector

The objective is to evaluate the affect of current market developments on their

entry mode decisions

In light of the financial crisis and the banks` rediscovery of the private individual

the German banking sector is currently experiencing a renaissance resulting in

increasing industry rivalry At the same time the processing of bank transactions

and customer services is becoming increasingly independent of the branch

distribution channel and the adoption of new technologies is substantially affecting

the allocation of retail banking services13 The technological evolution is

exemplified by the emergence of web-based direct banks which have been able to

penetrate the retail banking market with low-cost structures innovative ideas and

distinctive service thinking

Eventually the growing importance of the internet and other technological means

as distribution channels on the one hand and the remaining strong demand for

personal consultation on the other hand require a customer-oriented multi-channel

management of the banks14

This paper contrasts the two opposing ends in the field of retail banking

distribution channels It simplifies the entry mode choice between direct banks that

solely operate through the internet and brick amp mortar banks which solely operate

through a branch network Furthermore it differentiates between branch entry via

Greenfield investment and subsidiary entry via acquisition

Two major questions will be addressed

13 Deloitte (2010) 14 Welp (2009)

4

Firstly to what extent do demographic and technical developments favor a direct

bank entry mode over a brick and mortar bank approach in Germany

Secondly what affects the decision in favor of a branch entry mode via Greenfield

investment as compared to a subsidiary entry mode via acquisition in Germany

12 Structure

This thesis is systematically divided into two different complexes - a theoretical

and a practical After a classification of essential banking terms in the section 2

Section 3 then describes relevant market entry theories ndash namely the Transaction

Costs Theory and the Eclectic Theory as well as market entry strategies ndash namely

the offensive and the defensive strategies of expansion

In section 4 the German retail banking market is analyzed within the five forces

framework The goal of this examination is to evaluate market attractiveness and to

identify micro and macroeconomic developments that may shape the market in the

future

Given the theoretical framework of section 3 and the knowledge of industry

structure and trends of section 4 section 5 explores the decision driving factors of

entry mode choice In this section cross-border lending alliances joint ventures

and representations will be discussed Furthermore this section indicates what

affects the decision in favor of a branch entry mode via Greenfield investment as

compared to a subsidiary entry mode via acquisition and to what extent

demographic and technical developments favors a direct bank entry mode over a

brick and mortar bank entry mode in Germany

Section 6 introduces the SWOT analysis as well as the Service Marketing Mix and

applies these concepts to the ING - DiBa case study It illustrates how ING- DiBa

penetrated the German retail banking market with both the implementation of the

direct banking business model and the exploitation of external opportunities

Finally this thesis concludes with a summary of the major findings

5

2 Classification of Banks

21 Bank

This paper refers to banks as defined in the German Banking Act Section 1 GBA

defines financial institutes as enterprises which pursue banking transactions

insofar as the extent of these transactions requires commercial business operations

At least one of the following transactions has to be carried out security

transactions credit transactions payments transactions or other banking business

The enterprise which pursues banking transactions in Germany requires the

permission of the BaFin (Federal Institution for Finance Service Supervision)

according to section 32 GBA

22 Direct Bank

Direct banks are credit institutes which operate without a branch network and

utilize the internet and the telephone as direct communication channels through

which banking transactions are realized and marketing and customer service takes

place Thus direct banks establish cost advantages which they usually transmit in

the form of attractive terms15

23 Brick and Mortar Bank

A brick and mortar (BampM) company is a traditional street-side business that

deals with its customers face to face in an office that the company owns or rents16

A brick and mortar bank serves consumers in a physical facility as distinct from

providing online or telephone services only The term brick and mortar is not a

generally valid classification of a bank but in the jargon of e-commerce it is

frequently employed to distinguish from internet based enterprises In this thesis

the term brick and mortar bank is employed to differentiate between a direct bank

that operates through direct channels and one which operates solely through its

branch network The term brick and mortar is also distinguished from the term

click and mortar which is an expression for a form of multi-channel retailing in

15 Deutsche Bundesbank (2010) 16 Investopedia Dictionary (2010)

6

which both electronic distribution channels (click) and physical premises (mortar)

are utilized17

24 Multinational Bank

Multinational banks are defined as banks that have a physical presence in more

than one country In contrast international banks engage in cross-border operations

but do not establish a physical presence in foreign countries18

25 Retail Bank

There is no generally valid classification of retail banking in theoretical literature

or in practice19 A distinction in retail banking is often made with regard to its

target clientele In this regard some authors define retail banking as the offering of

banking and financial services to individuals and small and medium sized

enterprises20 Other sources define retail banking as the provision of these services

solely to individuals21 This paper employs the following classification of retail

banks `A retail bank is a bank that caters for ordinary individuals and small

business as distinct from large corporations Retail banking operations offer

deposit facilities lend money transfer funds and are prepared to deal in relatively

small amounts`22 In contrast to private and corporate banking retail banking

considers private clients with low to average income as well as small corporate

clients

2

Figure 1 Classification of retail banking clients

(own illustration based on Swoboda 2004)

17 Gabler Wirtschaftslexikon (2010) 18 Hersh and Weller (2002) 19 Muumlller and Joumlhnk (2005) 20 Pond (2007) FinanceWiki (2008) Tremblay and Tremblay (2007) 21 Frei Harker and Hunter (1998) Online Businessdictionarycom (2010) Investoglossarycom (2010) 22 Essvale Corporation Limited (2007)

Retail Banking

Medium and large corporate clients

Wealthy private clients

Small Corporate clients

Private clients

7

3 Market Entry Theories and Strategies

31 Transaction Costs Theory

In the transaction cost theory developed by Ronald Coase and Oliver E

Williamson a comparison of transaction costs determines the optimal form of

organization In TC Theory the entry mode decision is a tradeoff between the

control and the costs of resource commitment Entry modes vary in three major

aspects the cost of resource commitment control as the level of ownership and

environmental risks that may affect the committed resources Hence high-control

modes increase both risk and the potential return23

Williamson differentiates between ex-ante and ex-post transaction costs

Information and searching costs are incurred ex-ante in the process of collecting

market information and identifying suitable partners Negotiation and contract

costs arise ex-ante due to negotiations legal advisory and the determination of

contractual terms Monitoring costs develop ex-post for activities which serve to

control contractual obligations Conflict and enforcement costs arise ex-post due to

the different interpretation of the contract and the costs of enforcing contractual

regulations with sanctions negotiations or through court proceedings Adaption

costs are incurred due to ex-post changes in contractual agreements that become

necessary because of unpredictable developments24

TCE assumes the existence of bounded rationality and opportunism Bounded

rationality describes the limitation in human processing of information and the

planning of possible outcomes Opportunism describes the notion that humans may

act in a self-interested manner by manipulating information and being dishonest

The consequences of these assumptions are incomplete contracts and moral

hazards25 Vice versa opportunism occurs because firms can not write complete

contracts

The size of the transaction costs is determined in each case by the characteristics of

asset specificity uncertainty and frequency Asset specificity arises when the actor

in the market undertakes specific investments in order to fulfill his contractual 23 Chen and Mujtaba (2007) p322 24 Kieser and Ebers (2006) p278 25 Magill and Quenzii (1996) p11

8

obligations It refers to the degree to which long-lasting human or physical assets

are bound in a specific relationship and thus to the extent to which they provide

value in the context of a different situation26 In TCE markets can hardly solve the

problems that high uncertainty creates in combination with bounded rationality and

threats of opportunism Uncertainty includes environmental and behavioral

uncertainty Environmental uncertainty refers to political legal cultural and

economic uncertainties that may affect the success of business transactions

Behavioral uncertainty states that bounded rationality and the threat of opportunism

result in the high costs of monitoring a partner company27 If the similar

transactions are repeated frequently learning effects and economies of scale occur

and will reduce the transaction costs

32 Eclectic Theory

The eclectic theory28 (or OLI paradigm) was developed by John Dunning and is a

framework that merges different economic theories which explain foreign market

entry patterns of multinational corporations29 It states that the internationalization

of MNCs is determined by three sets of independent variables ownership

advantages (or firm- specific advantages) location advantages (or country specific

advantages) and internationalization advantages

The ownership advantage considers the competitive advantages of MNCs arising

from firm-specific characteristics such as size monopoly power economies of

scale management brand name technology and other resource capabilities30

These advantages are usually intangible assets and can be transferred at low costs31

The greater the competitive advantage of the MNC is the more likely it is able to

start or to increase its foreign production32

The location advantages arise from country specific benefits that can be divided

into three categories Firstly a host country may have economic advantages

comprising qualitative and quantitative factors such as production transports costs

26 Dietrich (1994) p18 27 Brouthers and Brouthers (2003) p1183 - 1185 28 Dunning (1980) Dunning (1988) Hill Kwang and Kim (1990) 29 Dunning (2002) 30 Forsbaeck and Oxelheim (2004) 31 Griffin and Pustay (2006) 32 Dunning (2002)

9

communication costs market size or tax incentives Secondly a host country may

offer political advantages in particular governmental policies that may influence

market entry Thirdly a host country may provide social and cultural advantages

including the psychic distance between the foreign and the domestic country as

well as language or cultural aspects that may have an impact on the market entry

decision The higher the attractions of the specific location the more likely it is that

MNCs will exploit their ownership advantage by entering the foreign market33

Because of the existence of transactions costs the internationalization incentive

advantage states that it must be profitable for the MNC to exploit these advantages

itself rather than through local companies (eg licensing)34

In economic literature the OLI paradigm has also been applied to the banking

sector In this regard ownership advantage may include easy access to a vehicle

currency Locational advantages may include country-specific regulations and

entry barriers Internationalization advantages can be information advantages and

access to local deposit bases35

Many empirical studies on the banking market have utilized the eclectic paradigm

as a basic framework For example a study of bank entry into CEE markets

concludes that the ownership advantages of foreign MNBs are strong compared to

banks in emerging markets and especially when the foreign country experiences a

banking crisis36 An application of the OLI paradigm to the Spanish banking

market has shown that bank size and multinational experience of MNBs favor

stronger commitment in the foreign country whereas distance is an entry barrier37

However theoretical literature also states that in service industries clients close to

the MNBs headquarters may be served from this location whereas clients in distant

markets require a physical presence of the MNB in the foreign country which

favors a foreign market entry with increasing distance38

33 Dunning (2002) 34 Hagen (1997) 35 Yannopoulus (1983) 36 Uiboupin and Sorg (2006) 37 Blandoacuten (1998) 38 Blondoacuten (1998) Terpstra and Yu (1988)

10

33 Strategy of Defensive Expansion

A common approach employed to explain the expansion of MNBs involves the

theory of defensive expansion which is also referred to as the acutefollow-the-

customeracute argument

This theory states that MNBs expand abroad in order to provide services for

domestic clients which are often large enterprises that have entered a foreign

market39 The provision of financial services in the foreign country usually requires

a presence at important economic centres Hence to some degree expanding

corporations impose pressure on their domestic banks to follow-up40

The term acutedefensiveacute is derived from the idea that a failure to expand may lead to a

loss of the client not only in the foreign country but also in the domestic one as

the client may associate with a foreign MNB41 Consequently MNBs which pursue

this strategy seek to prevent losses rather then to generate new profits in the foreign

market42 Furthermore the domestic bank has an incomparable competitive

advantage over banks in the foreign country with regard to the knowledge of

customer needs the respective risk of credit default as well as an interest in cross-

selling products such as financial advisory43

Due to earlier business relationships with the client the domestic bank has reduced

costs for examining the financial capacities of the respective enterprise and thus

can offer cheaper services44 Most foreign entry evidence supports the defensive

expansion theory45

A study on this theory with respect to retail banking has revealed that MNBs

sometimes expand abroad in order to provide banking services to specific

communities46

39 Trend im retail-banking koumlhler 40 Henneberger and Graf (2000) 41 Mullineux and Murinde (2003) 42 Naaborg (2007) 43 Knoop (2006) 44 Bhattacharya (1994) 45 Bhattacharya (1994) Naaborg (2007) 46 Tschoegl (1987)

11

34 Strategy of Offensive Expansion

MNBs that offensively expand abroad primarily seek to increase their customer

base both in the home and in the foreign country Firstly the establishment of

foreign branches and subsidiaries enables the MNB to expand their services to

domestic residents who benefit from the international orientation of the bank

These may include customers that have business partners in the foreign country

Secondly MNBs may target new customers in the foreign country in particular

MNEs or foreign subsidiaries of domestic enterprises As the MNB must in both

cases entice customers away from other banks the MNB has to offer attractive and

competitive conditions for their financial services47

47 Buumlschgen (1998) p604

12

4 Industry Analysis German Retail Banking Sector

41 Porter`s Five Forces

In the school of Industrial Economics the five-forces model has established itself

as a core element of industry analysis Porter`s analysis framework is built on the

following five market forces that shape the strategy of competitors threat of new

entrants threat of substitute products or services bargaining power of buyers and

suppliers as well as rivalry among existing competitors

Porterrsquos concept is based on the knowledge that the strategy of an enterprise must

orient itself to its market environment whereby the competitive strategy arises

from a differentiated understanding of the market structure and the knowledge of

how it changes The effects of these forces determine the intensity of the

competition in a market and with it its profitability and attractiveness Therefore

the aim of the enterprise strategy should be reflected in the search for possibilities

for the reduction or use of these competitive forces relative to its own enterprise In

this regard Porter`s model is conducive to the analysis of the driving forces

working in the respective industry

Figure 2 Michael E Porter`s five forces model (Own illustration based on Porter 1979)

Industry Rivalry

Threat of New

Entrants

Bargaining Power of

Buyers

Threat of Substitute Products

and Services

Bargaining Power of Suppliers

13

Porter`s framework is a useful and frequently utilized analytical tool to describe the

foundations of industry competition

A high degree of rivalry among the existing enterprises leads to high competitive

pressure and can lower profit margins and the profitability of individual

enterprises In situations in which a large number of enterprises target similar

market segments with comparable strategies in which the market grows slowly

price is the most important differentiation factor and high exit barriers exist a

negative impact on the industryrsquos profitability is effected48

The threat of new entrants can be determined by the entry barriers of a market The

competitive pressure on existing enterprises increases with low entry barriers In

such a situation important elements of the market (eg shares of the market price

level) can change due to the entry of new market participants49

The bargaining power of buyers determines to what extent customers can influence

enterprises by the amount of consumption and the pressure on margins Important

indexes of a high degree of buyer power include high fixed costs in the industry

existence of supplements of the product or service high degree of customer

concentration customers` knowledge of production costs possibility of a reverse

integration of customers high growth rates of the market and a strong

individualization of customer demand50

The bargaining power of suppliers affects industry profitability if for example a

concentrated supplier group dominates over existing enterprises in the market

which are not important buyers for the suppliers Then the industry faces high

margin pressure by the suppliers

A threat of substitute products and services exists in particular if cheaper or higher-

quality products and services are able to reduce existing sales volumes of a market

or an enterprise51 The future sales potential of existing enterprises becomes limited

and industry competition increases

48 Porter (1985) 49 Porter (1979) Recklies (2001) 50 Recklies (2001) 51 Recklies (2001)

14

Critics of this model state that it neglects the impact of complements as a sixth

force of the industry since they may facilitate or hinder the commercialization of

certain goods However Porter argues that complements are not a force itself but

they affect profitability in the way that they influence the five forces and that `the

strategist must trace the positive or negative influence of complements on all five

forces to ascertain their impact on profitability`52

One limitation of this model is based on studies which indicate that company-

specific factors may have a more important impact on profit than industry forces53

Furthermore the model suggests relatively static and stable market structure which

makes it difficult to assess contemporary dynamic markets54

The model does not assess the impact of the parent company on its subsidiary

which is especially important in the banking sector in which parent companies

often have a strong impact on the performance of their subsidiary or branch The

parenting advantage includes the stand-alone influence through monitoring and

influence on management decisions or capital expenses Furthermore parents

create value by enhancing synergies within the group offering corporate functions

or managing portfolios55

42 Rivalry among existing competitors

In this section the intensity of competitive rivalry among existing competitors in

the German retail banking sector is discussed In this regard an analysis of industry

structure industry growth and exit barriers will be conducted

Industry structure The German banking market is characterized by a three-pillar

system which is reflected by the strict distinction between public-law banks

cooperative banks and private banks56 Each pursues different goals and is subject

to different regulations Private commercial banks pursue the goal of profit

maximization whereas saving banks serve the public contract of offering secure

52 Porter (1997)p11 53 Zack (1999) 54 Recklies (2001) 55 Goold Cambpell and Alexander (1994) 56 Gramlich (2005)

saving possibilities and loans C

interest of their members

banking market is structured as follow

Figure 3(own illustration based on Sch

Public-law banks including saving banks and state banks

total balance sheet volume of banks in Germany

do not participate in retail banking The cooperative bank sector amounts to 11

the total including cooperative banks

cooperative central banks

commercial banks including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

31 of total balance sheet volume

European Research (ZWE) 43 of experts state that the three

important or very important and

for the low number of cross

In order to describe industry rivalry among maj

retail sector the following table illustrates the number of customers per bank in

Germany

57 Engerer (2006) 58 Koumlhler (2008b)

banks 24

Private commercial banks 31

15

possibilities and loans Cooperative banks primarily serve the economic

interest of their members57 In terms of total balance sheet volume the German

banking market is structured as follows

Figure 3 Structure of the German Banking Sector(own illustration based on Schrooten 2009)

law banks including saving banks and state banks amount to 33 of the

total balance sheet volume of banks in Germany However state banks

do not participate in retail banking The cooperative bank sector amounts to 11

including cooperative banks which participate in retail ban

cooperative central banks which primarily serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

alance sheet volume According to a recent survey of the Center for

European Research (ZWE) 43 of experts state that the three-pillar system is

important or very important and 33 state that it is the critical factor responsible

cross-border mergers and acquisitions in Germany

In order to describe industry rivalry among major banks that participate in the

the following table illustrates the number of customers per bank in

Savings banks 13

State banks 20

Cooperative central banks

3Credit cooperative banks 8

Other banks 24

serve the economic

sheet volume the German

Structure of the German Banking Sector

amount to 33 of the

However state banks generally

do not participate in retail banking The cooperative bank sector amounts to 11 of

participate in retail banking and

serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks amount to

According to a recent survey of the Center for

pillar system is

33 state that it is the critical factor responsible

border mergers and acquisitions in Germany58

or banks that participate in the

the following table illustrates the number of customers per bank in

State banks 20

Cooperative central banks

16

Figure 4 Customers of German Banks at the end of 2007 in millions (own illustration based on Deutsche Bank 2008)

With approximately 50 million customers savings banks are the market leader in

the German retail banking sector Although state liability assumption for savings

banks was abolished in 2005 because the EU saw in it an unacceptable subsidy to

the disadvantage of private banks customers still associate the name `Sparkasse`

with state guarantees The specific characteristic of a saving bank is based on its

public contract in that it has to accept customers with poor credit-worthiness that

profits should be used to enhance public wealth and that the middle class should be

supplied with loans59

With approximately 30 million customers cooperative banks are the second major

player in the German retail banking sector Nearly half of these customers are

members of the cooperative banks60 In contrast to the profit maximization goal of

private commercial banks their aim is to fund their members and secure their

economic independence Although cooperative banks are economically and legally

independent in the different regions they appear uniformly as a group under the

brand of ldquoVolks- und Raiffeisenbankenrdquo With regard to growth in customer base

cooperative banks benefit from the advantage of having the regional flexibility that

59 Kruck (2008) 60 Online Raiffeisen Bank Homepage

31

4

61

118

242

30

50

0 10 20 30 40 50 60

Citibank

Hypovereinsbank

ING DiBa

Commerzbank and Dresdner Bank

Postbank and Deutsche Bank

Credit Unions (Volksbanken)

Savings Banks (Sparkassen)

17

allows for topical advertisement as well as a centralized management focus on

improving reputation61

The third group comprises the major private commercial banks including Deutsche

Bank Postbank Commerzbank and Hypovereinsbank Deutsche Bank is a leading

multinational investment bank but with relatively low market share in the retail

banking market Deutsche Bank (97 million clients) is acquiring Postbank (145

million clients) with its broad branch network in a three-step process Together

they have 242 million clients However Heino Ruland from the analyst company

Frankfurt Finanz Partner argues that Deutsche Bank might not be able to capitalize

on the financially weaker Postbank clients as Deutsche Bank is specialized in

corporate clients62 With regard to rivalry intensity and market profitability Rainer

Neske supervisory board member and head of private amp business clients of

Deutsche Bank emphasizes that the German retail banking market is too

fragmented to be highly profitable and that Deutsche Bank does not seek to

compete on the price level but defines itself through performance quality and

consultancy63

Commerzbank is the second largest private commercial bank in Germany After the

acquisition of Dresdner Bank in 2009 Commerzbank now serves more than 12

million clients (of these 11 million private and one million corporate clients) and

pursues the goal of becoming the market leader in Germany64

UniCredit Bank AG with the brand name Hypovereinsbank (HVB) is a subsidiary

of UniCredirSpA and is the third largest private commercial bank in Germany

HVB serves approximately four million clients predominantly in north Germany

and in Bavaria As its retail banking segment could only report marginal profits in

2009 speculation about a sale or acquisition in this segment has come up As the

Swedish SEB (Skandinaviska Enskilda Bank) is considering selling its German

retail segment with 174 branches and one million clients experts now regard HVB

as a major buying candidate65

61 Schwarzbauer (2009) 62 Kreiler (2008) 63 Deutsche Bank (2009) 64 Kreiler (2008) 65 Houmlpner and Nagl (2010)

18

ING DiBa AG is a subsidiary of the Dutch ING Group and serves over 6 million

clients In contrast to savings cooperative and the major private commercial

banks ING DiBa is specialized in direct banking which distributes services via

telephone the internet or post instead of through branches In Germany ING

DiBa is the leader in direct banking but there are many other direct banks such

as Comdirect (a subsidiary of Commerzbank) Volkswagen Bank or DAB Bank

(a subsidiary of HVB) Competition takes place not only among direct banks but

also between direct and branch banks For instance many saving banks have

blocked the opportunity for customers of direct banks to withdraw cash from their

automated teller machines As savings banks can only charge Euro 174 for

withdrawals via visa cards they fear that direct banks can gain market share by

offering attractive account options with a convenient wide-area ATM provision66

Targobank (former Citibank Deutschland) was acquired by the French

cooperative bank Creacutedit Mutel and now serves more than 34 million clients in

Germany in 2010 The bank is specialized in private retail customers with

branches and direct banking67

In conclusion the degree of concentration in the German retail banking market is

very low which reduces the overall profitability of this sector for two main

reasons Banks earn higher profits in concentrated markets as they obtain either

monopoly rents (structure-conduct-performance paradigm) or due to high market

shares that are gained by more efficient and profitable banks (efficient structure

hypothesis)68 As retail banking services are largely standardized product

differentiation is low and price differentiation is often the only option As public-

law banks serve other interests than profit maximization existing private banks

and MNBs that want to enter this market have a competitive disadvantage The

low switching costs of clients intensifies competition on the price level and thus

reduces the profitability of the market However brand identification and

customer relationships are also important which decreases the willingness of

clients to switch solely on the basis of price comparison In summary market

structure indicates a very high degree of rivalry among existing competitors

66 Online Financial Times Deutschland (2010) 67 Targobank (2010) 68 Havrylchyk and Jurzyk (2006) p15

19

Industry growth In this section industry growth will be examined in a dynamic

analysis of three relevant market growth indicators the future long-run

development of the German population the historical development of the number

of banks and branches in Germany and the historical development of market-

share allocation in the context of major retail banking activities

In the long-run market growth depends on the future numerical development of

the market`s customers - the German population As the growth of population

through birth and immigration is smaller than its decrease by virtue of the mortality

rate and emigration the Federal Statistical Office in Germany estimates a sharp

decline of the German population

Figure 5 Estimated Development of German Population (in millions)

(Federal Statistical Office 2009)

The Federal Statistical Office predicts that the trend of decline in population since

2003 will continue and intensify Whereas approximately 82 million people lived

in Germany in 2008 only between 65 million (average lower limit of the

population with 100000 immigrants yearly) and 70 million people (average

upper limit of the population with 200000 immigrants yearly) will reside in

Germany in 2060 Furthermore the decreasing number of births and the ageing of

the current strongly represented middle age group will lead to substantial changes

in the age structure of the population From 2008 to 2060 the proportion of people

from 65 to 80 years will increase 15 to 20 and the proportion of people over

80 years of age will increase from 5 to 14 of the population69 The

69 Federal Statistical Office (2009)

Average lower limit

Average upper limit

20

implications of the aging population for banks will be discussed in the comparison

between direct banks and BampM banks in section 66 of this thesis

The second indicator of industry growth deals with the number of banks and bank

branches in the German market The overall number of banks in Germany

decreased from 3785 in 1995 to 2300 in 2006 As retail banking usually depends

on the number branches maintained their development in Germany will be

examined

Figure 6 Development of Total Bank Branches in Germany (own illustration based on Koumlhler2008a)

Savings banks and cooperative banks have reduced the number of branches

significantly Public-sector banks (savings banks state banks etc) with 18757

branches and cooperative banks with 16028 branches in 1998 reduced the

number of branches to 14252 and 12303 respectively in 2006 Moreover the

number of branches of major commercial banks decreased from 19055 in 1998 to

8879 in 2006

The main cause for the decrease of branches is the high fixed costs which can not

be recouped from low-revenue standard products that can also be distributed

through alternative low-cost channels such as the internet70

70 Koumlhler and Land (2008)

67930 6666363186

59929 58546 5693653931

5086847244 45467 44100

40332

0

10000

20000

30000

40000

50000

60000

70000

80000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

21

As a third indicator of industry growth this paper reflects on the allocation of

market share within the retail banking sector in order to indentify trends that may

affect overall market growth This paper will reflect on market share in two major

retail banking segments - savings deposits and loans The German Central Bank

classifies the banking market in terms of savings banks cooperative banks direct

banks and credit banks The latter include universal banks which are private

commercial banks branches of foreign banks regional banks and other private

banks

This section reflects the development of market share regarding short- medium-

and long-term saving accounts and examines the allocation of loans to corporate

clients consumers (consumer loans) private households and self-employed

persons

In the period from 1998 to 2006 the market for medium-term saving deposits with

a cancellation period under three months has been dominated by saving banks (53

market share in 2006) and cooperative banks (29 market share in 2006) In the

same period the market share for long-term saving deposits with a cancellation

period above three months has also continuously been dominated by savings banks

(65 market share in 2006) and cooperative banks (24 market share in 2006)

However with regard to deposits that mature daily direct banks were able to

increase market share from approximately 15 in 1998 to over 15 in 2006

Figure 7 Market share development of saving accounts that mature daily (own illustration based on Deutsche Bundesbank 2007)

000

500

1000

1500

2000

2500

3000

3500

4000

4500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Banks

Cooperative Banks

Savings Banks

Credit Banks

22

From 1998 to 2006 market share for loans for corporate clients has been

continuously dominated by credit banks (53 market share in 2006) and savings

banks (34 market share in 2006) However this data also comprises loans for

medium and large corporations which are not part of the retail banking market

Loans for private households and self-employed persons have predominately been

granted by savings banks (39 market share in 2006) credit banks (30 market

share in 2006) and cooperative banks (25 market share in 2006) though direct

banks were able to gain some market share from 0 in 1998 up to 5 in 2006

Even more significantly direct banks were able to gain over 16 market share in

the segment of consumer loans

Figure 8 Market share development of consumer loans (own illustration based on Deutsche Bundesbank 2007)

Hence the most significant growth indicator of the retail banking market results

from the emergence of direct banks which were able to gain substantial market

share in consumper loans and deposits that mature daily

In conclusion the industry growth analysis indentifies the following growth

indicators Firstly a sharp decrease in the German population in the following

decades will reduce growth and increase industry rivalry Moreover the

demographic change increases the proportion of old people in the population

Secondly the number of branches in Germany is decreasing due to high fixed

costs of branches In order to be profitable in retail banking the existing branches

must serve a large quantity of customers which leads to strong competition

relative to market share Thirdly the development of market share allocation

000

1000

2000

3000

4000

5000

6000

7000

2002 2003 2004 2005 2006

Savings Banks

Cooperative Banks

Direct Banks

Credit Banks

23

indicates that only direct banks have experienced significant growth from 1995 to

2006

Exit barriers From a perspective of Transaction Costs Economics one can argue

that exit barriers in branch banking are high for market participants as branches

and staff are highly specific assets that lose value when used in another situation

To a large extent these assets are locked into the context of retail banking

Moreover public-law banks usually have to serve the population regardless of

whether they are profitable or not In a situation in which a bank continuously

experiences losses staff and branches may be considered as sunk costs and thus

economically `irrationalacute exit barriers However theories suggest that staff and

branches are practically valid exit barriers and cause MNCs to stay in a market71

The high degree of exit barriers intensifies the strong rivalry among existing

competitors

43 Threat of New Entrants

New entrants usually seek to gain market share while applying pressure on prices

and costs and thus increasing the investments necessary to compete An expert

survey conducted by the ZEW emphasizes the importance of entry threat to the

German retail-banking market 6666 of market experts state that new

competitors (eg foreign banks) have an important or a very important impact on

industry rivalry72

In this section the threat of new entrants to existing market participants in the

German retail banking sector is discussed In this regard this section evaluates

legal entry barriers capital requirements the necessity of large scale operations

customer switching costs and incumbency advantages of existing domestic banks

Legal entry barriers are determined by governmental regulations in the German

Banking Act (GBA) and are supervised by the Federal Supervisory Authority73

According to section 32 para 1 (1) GBA companies that intend to pursue

commercial banking transactions or financial services in Germany require written

71 Hill Hwang and Kim (1990) 72 Koumlhler and Lang (2008) 73 Bundesanstalt fuumlr Finanzdienstleistungsaufsicht (2005)

24

permission from the Federal Financial Supervisory Authority ( ldquoBundesanstalt fuumlr

Finanzdienstleistungaufsichtrdquo) The execution of banking transactions or financial

services also exists when the operator has its headquarters or primary residence

abroad but repeatedly targets companies or individuals who have their primary

residence in Germany In order to obtain the permit several requirements are

examined (eg business plan qualified management etc)

Companies from third countries which intend to conduct banking transactions and

provide financial services in Germany must establish a subsidiary (section 32 para

1 in connection with ection 33 para 1 (6) GBA) or a branch (section 32 para 1 in

connection with section 53 GBA) in Germany Companies from third countries can

apply for an exemption according to section 2 para 4 GBA if the company is

supervised utilizing international accounting standards in the home country and the

responsible authority works together with the BaFin According to section 53b

GBA companies of EEA states are allowed to establish branches (section 53b para

2) but are also free to conduct cross-border financial services without a domestic

presence (section 53b para 2a) Section 32 para 1 GBA does not apply to business

that is motivated by the initiative of the domestic individual or enterprise (so called

passive service freedom)

Representations are limited to their representative function and are not allowed to

conduct or initiate any banking business

Capital requirements are low for cross-border lending and and relatively low for

representations With high equity modes such as branches and even more so with

subsidiaries capital requirements are relatively high as capital is required for

building a broad network of facilities and offering credit to customers Capital

requirements for direct banks are relatively low compared with those of BampM

banks

The necessity of large scale operation is related to the competitive advantage of

economies of scale A company that serves the market in the context of larger

quantities benefits from lower cost per unit In retail banking profit is gained by

having a large number of clients It is expensive to build up these numbers and to

establish a distribution network to serve them This necessity relates directly to the

strategy of the bank An acquisition offers a shortcut to these facilities although the

25

costs of integration can be high as well74 A MNB may also decide to target only a

certain geographical area with certain clients and therefore do not have to enter on

a very large scale

Customer switching costs are different for each individual In general customers

can easily change their banks and open a deposit account or apply for a loan at

another bank However they have to compare the different terms for usually small

transactions to evaluate the convenience of having a bank nearby and then to

decide to terminate the relationships with their current bank75

Finally the incumbency advantages of existing banks are important entry barriers

In particular they include established brand reputation possession of the most

favorable geographical locations and market knowledge Moreover established

banks may already have exclusive contracts with SMEs76

To conclude legal entry barriers are low and particularly low for banks from the

EEA Capital requirements for entering the market are high yet as far as equity

entry modes are concerned direct banks require relatively low capital as they

distribute their services through low-cost channels Banks need to attract many

customers to be profitable but banks strategy dictates whether or not to entrance

should occur on a large scale Moreover the incumbency advantages of existing

banks constitute important entry barriers

44 Threat of Substitute Products or Services

A substitute in retail banking is a service that offers an attractive trade-off to a bank

service or product As individuals and small firms do not regularly report financial

information as do large enterprises they rely primarily on bank lending However

there are additional forms of financing in the private equity or dept market77

Many non- and near- banks provide substitute products and services Near-banks or

quasi-banks are suppliers of financial services but are not classified as credit

institutes according to section 1 GBA Near-banks such as insurance companies or

credit card organizations however do provide substitute products or services Non-

74 Hughes and MacDonald (2009) 75 Adams (2002) 76 Adams (2002) 77 Xiaoqin and Terada-Hagiwara (2003)

26

banks such as department store chains catalog companies or car producers also

provide substitute services78 For instance instead of taking out a loan in order to

pay for a product individuals or small enterprises may decide to take on a leasing

contract for a certain asset or small enterprises can obtain a trade credit as well

Individuals may decide on buying products from insurance companies instead of

putting money into a bank account

Another substitute for both direct and BampM banks is the person-to-person (p2p)

lending business a new form of borrowing and lending money that takes place in a

web-based market place In this online platform borrowers are connected to

lenders through an auction-like process in which a lender who bids to provide a

loan for the lowest interest rate will be awarded the loan contract with the

borrower A p2p company mediates between private or company borrowers and

lenders and also executes transactions between the parties similar to the role which

e-bay plays in the trade of commercial goods79 The p2p lending business does not

involve traditional banks and thus can offer superior interest rates to borrowers and

higher returns for lenders

45 Bargaining Power of Suppliers

When a supplier group is more concentrated than the industry does not primarily

depend on the industry and when the industry faces high switching costs the

supplier group has strong bargaining power and can reduce the profit potential of

an industry In the retail banking market the most relevant suppliers include human

resources suppliers of capital resources and suppliers of information and

communication technology (ICT)80 Highly talented or experienced specialists are

strongly canvassed and have strong bargaining power with respect to their salary

and working conditions However in the aftermath of the financial crisis many

banks are planning a reduction of staff According to a study of Ernst amp Young

every fifth bank intends to decrease staff and only every 10th bank is planning an

increase81 Given the current situation of the employment market the bargaining

power of employees is relatively low Suppliers of highly specialized banking ICT

78 Gabler Wirtschaftslexikon (2010) 79 Deloitte (2009) p 12 80 Buumlschgen and Boumlrner (2003) 81 Ernst amp Young (2009)

27

solutions have strong bargaining power as switching costs for these systems are

very high Moreover the higher yield requirements of shareholders can be

interpreted as supplier power

46 Bargaining Power of Buyers

In retail banking there are many buyers with relatively low transaction volumes

which weakens their bargaining power However retail banking services are

standardized and buyers can easily find similar services Switching costs have

usually been relatively high for these low volume transactions but in the age of the

internet the market is very transparent and buyers can screen different offerings

more easily This does not necessarily imply that the cheapest banking service will

be chosen automatically as customers also seek a trustworthy brand especially in

times of financial crisis Moreover there are other factors that affect the switching

cost of the individual such as the location of the branch Yet there is a tendency

towards the increasing bargaining power of buyers

This is also substantiated by the ZEW survey 7984 of market experts state that

decreasing customer loyalty and increasing price sensibility are important or very

important factors with respect to the intensity of competition in the German retail

banking sector A comparison of former and modern retail customers also indicates

that the bargaining power of retail banking service users has increased

Former Retail Customer Modern Retail Customer

Passive information seeking

behavior

Active information seeking behavior

Hardy or little informed Good to very good know-how

High customer loyality Increasing willingness to switch

Fixation on the branch Expects multi-channel banking at all times

and places

Little market transparency High price transparency

Relatively undemanding Demanding

Figure 9 Comparison of former and modern retail customers (own illustration based on Swoboda 2004)

28

5 Foreign Bank Entry Strategies in Germany

This section illustrates mode choices for foreign bank entry in Germany Based on

the hierarchical model of market entry modes82 the foreign bank has the choice of

equity and non ndash equity modes of entry An advantage of the hierarchical model is

that it allows comparing between entry modes on different levels The main

difference between equity and non ndash equity modes is the degree of resource

commitment in the foreign country As classified at the beginning of this thesis

non-equity entry refers to international banking and equity entry refers to

multinational banking

The research question of this thesis considers multinational bank entry modes

International banking however is often a first step towards multinational banking

Hence this thesis will also discuss cross-border lending and alliances as non ndash

equity entry modes The following figure illustrates a comprehensive view of

market entry modes for banks

Figure 10 A hierarchical model of entry mode choices for banks (own illustration based on Pan and Tse 2000)

82 Pan and Tse (2000)

Entry Mode Choices

Non - Equity Modes

Export

Cross Border Lending

Contractual Agreements

Alliances

Equity Modes

Equity Joint Ventures

Greenfield Investment

Branch

Subsidiary

Representation

Acquisition

Subsidiary

Branch

29

The hierarchical model illustrates the various entry mode choices for entering the

German retail banking market The creation of a common European financial

market in which banks can integrate freely is a major goal of the European Union83

The previous section of this paper indicates that entry barriers are relatively low

and that the German market is highly competitive Hence the choice of a proper

entry mode which is appropriate to the capabilities and the strategy of the bank is

even more significant Therefore the following section will reflect on the strategic

concept governing the choice of entry modes as well as the proliferation of these

entry modes in the German retail banking market

An international bank that is not interested in investing equity in the foreign

market can enter by means of cross-border lending or by forming a non-equity

alliance These non-equity entry modes can help the bank to access niche markets

or to exploit locational advantages when the bank is located near the German

border

However a retail bank defined in the beginning of this paper as a bank that

`caters for ordinary individuals and small businessacute and that seeks to enter the

German market in order to gain significant revenue from deposits and loan

business might have to consider a physical presence in the foreign country

The analysis considers entry modes that are perceived as international banking

cross-border lending and non-equity strategic alliances Furthermore the equity

modes JVs and representations will be discussed

Subsequently this section compares the market entry of a branch through

Greenfield investment with the market entry of a subsidiary by virtue of

acquisition as these modes of entry are the most common in the German retail

banking market

Finally the following question will be addressed to what extent do demographic

and technical trends favor a direct bank entry mode over a brick and mortar bank

approach in Germany

83 Fidrmuc and Hainz (2008)

30

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks (own illustration)

51 Non ndash equity modes Export ndash Cross-Border Lending

Cross-border lending is equivalent to the export entry mode and is a simple non-

equity strategy to enter a foreign market A bank which participates in cross-

border lending must assess the creditworthiness of the individual borrower as well

as the country risk which involves the possibility that these loans will be impaired

by economic or political proceedings in the foreign country84 The country risk in

Germany is rather low as it is perceived to have a solid political and economic

situation (Country Rating A2) with a stable and a very efficient business

environment (Country Rating A1)85 As a bank will only have limited access to soft

information about the creditworthiness of the borrower the availability of loans

usually decreases and the interest on loans usually increases with distance86 Soft

information for private loans includes the previous experience with the account

management of the credit user environmental facts and a judgment relative to his

employment contract87 For corporate loans soft facts may include the market

environment corporate structure management a business plan as well as

84 Hughes and McDonald (2003) 85 Online wwwtrade-safelycom (2009) 86 Agrawal and Hauswald (2007) 87 Dizil (2009)

Entry Mode Choices of MNBs

Greenfield Investment

Branch

Brick and Mortar Bank Direct Bank

Acquisition

Subsidiary

Brick and Mortar Bank Direct Bank

2

easily as before On the consumer side the financial crisis has increased the

demand for secure money investments A survey of 230 highly ranked managers

from private savings and co-operative banks on the effects of the crisis on their

business indicates that banks have concentrated more intensively on business with

private customers both during and after the latest crisis Moreover customer

demand for certificates company shares or funds has fallen significantly while the

demand for standard retail banking products such as call money accounts or

account books has increased substantially8

In spite of its high competitiveness and low profit margins the German retail

banking market is still attractive for foreign banks Foreign MNBs are increasingly

able to penetrate the market for private individuals9 In particular they gain market

share through new products decreasing prices standardized processes and

innovative marketing whereas domestic banks have often relied on continued

customer loyalty10 Although foreign multinational banks in Germany have usually

concentrated on large domestic corporations engaged in international

transactions11 they now enter the market for private and small corporate clients as

well12- a trend that has been supported by the development of internet technology

and other new marketing - channel options

The distinctive characteristics of the German banking market raise several

questions concerning both entry mode and business model considerations of

multinational banks Should a multinational bank engage in cross-border lending or

rather enter the market via foreign direct investment How do the development of

economic political-legal and social-cultural factors in the German market affect a

multinational bank`s entry mode and business model choice

This thesis distinguishes between the non - equity entry modes of cross-border

lending and alliances as well as the equity entry modes of representative offices

branches subsidiaries and JVs both from a Greenfield investment and an

acquisition point of view Each of these organizational entry mode forms has

8 Welp (2009) 9 Reitz (2005) 10 McKinsey amp Company (2007) 11 Hersh and Weller (2002) 12 Koumlhler (2008)

3

distinctive advantages and disadvantages Hence the main focus of this thesis is to

provide a broad understanding of the distinctive market entry and penetration

strategies in light of macro and micro economical developments in Germany

11 Research Objective

This thesis examines entry mode choice decisions and business model

considerations of multinational banks entering the German retail banking sector

The objective is to evaluate the affect of current market developments on their

entry mode decisions

In light of the financial crisis and the banks` rediscovery of the private individual

the German banking sector is currently experiencing a renaissance resulting in

increasing industry rivalry At the same time the processing of bank transactions

and customer services is becoming increasingly independent of the branch

distribution channel and the adoption of new technologies is substantially affecting

the allocation of retail banking services13 The technological evolution is

exemplified by the emergence of web-based direct banks which have been able to

penetrate the retail banking market with low-cost structures innovative ideas and

distinctive service thinking

Eventually the growing importance of the internet and other technological means

as distribution channels on the one hand and the remaining strong demand for

personal consultation on the other hand require a customer-oriented multi-channel

management of the banks14

This paper contrasts the two opposing ends in the field of retail banking

distribution channels It simplifies the entry mode choice between direct banks that

solely operate through the internet and brick amp mortar banks which solely operate

through a branch network Furthermore it differentiates between branch entry via

Greenfield investment and subsidiary entry via acquisition

Two major questions will be addressed

13 Deloitte (2010) 14 Welp (2009)

4

Firstly to what extent do demographic and technical developments favor a direct

bank entry mode over a brick and mortar bank approach in Germany

Secondly what affects the decision in favor of a branch entry mode via Greenfield

investment as compared to a subsidiary entry mode via acquisition in Germany

12 Structure

This thesis is systematically divided into two different complexes - a theoretical

and a practical After a classification of essential banking terms in the section 2

Section 3 then describes relevant market entry theories ndash namely the Transaction

Costs Theory and the Eclectic Theory as well as market entry strategies ndash namely

the offensive and the defensive strategies of expansion

In section 4 the German retail banking market is analyzed within the five forces

framework The goal of this examination is to evaluate market attractiveness and to

identify micro and macroeconomic developments that may shape the market in the

future

Given the theoretical framework of section 3 and the knowledge of industry

structure and trends of section 4 section 5 explores the decision driving factors of

entry mode choice In this section cross-border lending alliances joint ventures

and representations will be discussed Furthermore this section indicates what

affects the decision in favor of a branch entry mode via Greenfield investment as

compared to a subsidiary entry mode via acquisition and to what extent

demographic and technical developments favors a direct bank entry mode over a

brick and mortar bank entry mode in Germany

Section 6 introduces the SWOT analysis as well as the Service Marketing Mix and

applies these concepts to the ING - DiBa case study It illustrates how ING- DiBa

penetrated the German retail banking market with both the implementation of the

direct banking business model and the exploitation of external opportunities

Finally this thesis concludes with a summary of the major findings

5

2 Classification of Banks

21 Bank

This paper refers to banks as defined in the German Banking Act Section 1 GBA

defines financial institutes as enterprises which pursue banking transactions

insofar as the extent of these transactions requires commercial business operations

At least one of the following transactions has to be carried out security

transactions credit transactions payments transactions or other banking business

The enterprise which pursues banking transactions in Germany requires the

permission of the BaFin (Federal Institution for Finance Service Supervision)

according to section 32 GBA

22 Direct Bank

Direct banks are credit institutes which operate without a branch network and

utilize the internet and the telephone as direct communication channels through

which banking transactions are realized and marketing and customer service takes

place Thus direct banks establish cost advantages which they usually transmit in

the form of attractive terms15

23 Brick and Mortar Bank

A brick and mortar (BampM) company is a traditional street-side business that

deals with its customers face to face in an office that the company owns or rents16

A brick and mortar bank serves consumers in a physical facility as distinct from

providing online or telephone services only The term brick and mortar is not a

generally valid classification of a bank but in the jargon of e-commerce it is

frequently employed to distinguish from internet based enterprises In this thesis

the term brick and mortar bank is employed to differentiate between a direct bank

that operates through direct channels and one which operates solely through its

branch network The term brick and mortar is also distinguished from the term

click and mortar which is an expression for a form of multi-channel retailing in

15 Deutsche Bundesbank (2010) 16 Investopedia Dictionary (2010)

6

which both electronic distribution channels (click) and physical premises (mortar)

are utilized17

24 Multinational Bank

Multinational banks are defined as banks that have a physical presence in more

than one country In contrast international banks engage in cross-border operations

but do not establish a physical presence in foreign countries18

25 Retail Bank

There is no generally valid classification of retail banking in theoretical literature

or in practice19 A distinction in retail banking is often made with regard to its

target clientele In this regard some authors define retail banking as the offering of

banking and financial services to individuals and small and medium sized

enterprises20 Other sources define retail banking as the provision of these services

solely to individuals21 This paper employs the following classification of retail

banks `A retail bank is a bank that caters for ordinary individuals and small

business as distinct from large corporations Retail banking operations offer

deposit facilities lend money transfer funds and are prepared to deal in relatively

small amounts`22 In contrast to private and corporate banking retail banking

considers private clients with low to average income as well as small corporate

clients

2

Figure 1 Classification of retail banking clients

(own illustration based on Swoboda 2004)

17 Gabler Wirtschaftslexikon (2010) 18 Hersh and Weller (2002) 19 Muumlller and Joumlhnk (2005) 20 Pond (2007) FinanceWiki (2008) Tremblay and Tremblay (2007) 21 Frei Harker and Hunter (1998) Online Businessdictionarycom (2010) Investoglossarycom (2010) 22 Essvale Corporation Limited (2007)

Retail Banking

Medium and large corporate clients

Wealthy private clients

Small Corporate clients

Private clients

7

3 Market Entry Theories and Strategies

31 Transaction Costs Theory

In the transaction cost theory developed by Ronald Coase and Oliver E

Williamson a comparison of transaction costs determines the optimal form of

organization In TC Theory the entry mode decision is a tradeoff between the

control and the costs of resource commitment Entry modes vary in three major

aspects the cost of resource commitment control as the level of ownership and

environmental risks that may affect the committed resources Hence high-control

modes increase both risk and the potential return23

Williamson differentiates between ex-ante and ex-post transaction costs

Information and searching costs are incurred ex-ante in the process of collecting

market information and identifying suitable partners Negotiation and contract

costs arise ex-ante due to negotiations legal advisory and the determination of

contractual terms Monitoring costs develop ex-post for activities which serve to

control contractual obligations Conflict and enforcement costs arise ex-post due to

the different interpretation of the contract and the costs of enforcing contractual

regulations with sanctions negotiations or through court proceedings Adaption

costs are incurred due to ex-post changes in contractual agreements that become

necessary because of unpredictable developments24

TCE assumes the existence of bounded rationality and opportunism Bounded

rationality describes the limitation in human processing of information and the

planning of possible outcomes Opportunism describes the notion that humans may

act in a self-interested manner by manipulating information and being dishonest

The consequences of these assumptions are incomplete contracts and moral

hazards25 Vice versa opportunism occurs because firms can not write complete

contracts

The size of the transaction costs is determined in each case by the characteristics of

asset specificity uncertainty and frequency Asset specificity arises when the actor

in the market undertakes specific investments in order to fulfill his contractual 23 Chen and Mujtaba (2007) p322 24 Kieser and Ebers (2006) p278 25 Magill and Quenzii (1996) p11

8

obligations It refers to the degree to which long-lasting human or physical assets

are bound in a specific relationship and thus to the extent to which they provide

value in the context of a different situation26 In TCE markets can hardly solve the

problems that high uncertainty creates in combination with bounded rationality and

threats of opportunism Uncertainty includes environmental and behavioral

uncertainty Environmental uncertainty refers to political legal cultural and

economic uncertainties that may affect the success of business transactions

Behavioral uncertainty states that bounded rationality and the threat of opportunism

result in the high costs of monitoring a partner company27 If the similar

transactions are repeated frequently learning effects and economies of scale occur

and will reduce the transaction costs

32 Eclectic Theory

The eclectic theory28 (or OLI paradigm) was developed by John Dunning and is a

framework that merges different economic theories which explain foreign market

entry patterns of multinational corporations29 It states that the internationalization

of MNCs is determined by three sets of independent variables ownership

advantages (or firm- specific advantages) location advantages (or country specific

advantages) and internationalization advantages

The ownership advantage considers the competitive advantages of MNCs arising

from firm-specific characteristics such as size monopoly power economies of

scale management brand name technology and other resource capabilities30

These advantages are usually intangible assets and can be transferred at low costs31

The greater the competitive advantage of the MNC is the more likely it is able to

start or to increase its foreign production32

The location advantages arise from country specific benefits that can be divided

into three categories Firstly a host country may have economic advantages

comprising qualitative and quantitative factors such as production transports costs

26 Dietrich (1994) p18 27 Brouthers and Brouthers (2003) p1183 - 1185 28 Dunning (1980) Dunning (1988) Hill Kwang and Kim (1990) 29 Dunning (2002) 30 Forsbaeck and Oxelheim (2004) 31 Griffin and Pustay (2006) 32 Dunning (2002)

9

communication costs market size or tax incentives Secondly a host country may

offer political advantages in particular governmental policies that may influence

market entry Thirdly a host country may provide social and cultural advantages

including the psychic distance between the foreign and the domestic country as

well as language or cultural aspects that may have an impact on the market entry

decision The higher the attractions of the specific location the more likely it is that

MNCs will exploit their ownership advantage by entering the foreign market33

Because of the existence of transactions costs the internationalization incentive

advantage states that it must be profitable for the MNC to exploit these advantages

itself rather than through local companies (eg licensing)34

In economic literature the OLI paradigm has also been applied to the banking

sector In this regard ownership advantage may include easy access to a vehicle

currency Locational advantages may include country-specific regulations and

entry barriers Internationalization advantages can be information advantages and

access to local deposit bases35

Many empirical studies on the banking market have utilized the eclectic paradigm

as a basic framework For example a study of bank entry into CEE markets

concludes that the ownership advantages of foreign MNBs are strong compared to

banks in emerging markets and especially when the foreign country experiences a

banking crisis36 An application of the OLI paradigm to the Spanish banking

market has shown that bank size and multinational experience of MNBs favor

stronger commitment in the foreign country whereas distance is an entry barrier37

However theoretical literature also states that in service industries clients close to

the MNBs headquarters may be served from this location whereas clients in distant

markets require a physical presence of the MNB in the foreign country which

favors a foreign market entry with increasing distance38

33 Dunning (2002) 34 Hagen (1997) 35 Yannopoulus (1983) 36 Uiboupin and Sorg (2006) 37 Blandoacuten (1998) 38 Blondoacuten (1998) Terpstra and Yu (1988)

10

33 Strategy of Defensive Expansion

A common approach employed to explain the expansion of MNBs involves the

theory of defensive expansion which is also referred to as the acutefollow-the-

customeracute argument

This theory states that MNBs expand abroad in order to provide services for

domestic clients which are often large enterprises that have entered a foreign

market39 The provision of financial services in the foreign country usually requires

a presence at important economic centres Hence to some degree expanding

corporations impose pressure on their domestic banks to follow-up40

The term acutedefensiveacute is derived from the idea that a failure to expand may lead to a

loss of the client not only in the foreign country but also in the domestic one as

the client may associate with a foreign MNB41 Consequently MNBs which pursue

this strategy seek to prevent losses rather then to generate new profits in the foreign

market42 Furthermore the domestic bank has an incomparable competitive

advantage over banks in the foreign country with regard to the knowledge of

customer needs the respective risk of credit default as well as an interest in cross-

selling products such as financial advisory43

Due to earlier business relationships with the client the domestic bank has reduced

costs for examining the financial capacities of the respective enterprise and thus

can offer cheaper services44 Most foreign entry evidence supports the defensive

expansion theory45

A study on this theory with respect to retail banking has revealed that MNBs

sometimes expand abroad in order to provide banking services to specific

communities46

39 Trend im retail-banking koumlhler 40 Henneberger and Graf (2000) 41 Mullineux and Murinde (2003) 42 Naaborg (2007) 43 Knoop (2006) 44 Bhattacharya (1994) 45 Bhattacharya (1994) Naaborg (2007) 46 Tschoegl (1987)

11

34 Strategy of Offensive Expansion

MNBs that offensively expand abroad primarily seek to increase their customer

base both in the home and in the foreign country Firstly the establishment of

foreign branches and subsidiaries enables the MNB to expand their services to

domestic residents who benefit from the international orientation of the bank

These may include customers that have business partners in the foreign country

Secondly MNBs may target new customers in the foreign country in particular

MNEs or foreign subsidiaries of domestic enterprises As the MNB must in both

cases entice customers away from other banks the MNB has to offer attractive and

competitive conditions for their financial services47

47 Buumlschgen (1998) p604

12

4 Industry Analysis German Retail Banking Sector

41 Porter`s Five Forces

In the school of Industrial Economics the five-forces model has established itself

as a core element of industry analysis Porter`s analysis framework is built on the

following five market forces that shape the strategy of competitors threat of new

entrants threat of substitute products or services bargaining power of buyers and

suppliers as well as rivalry among existing competitors

Porterrsquos concept is based on the knowledge that the strategy of an enterprise must

orient itself to its market environment whereby the competitive strategy arises

from a differentiated understanding of the market structure and the knowledge of

how it changes The effects of these forces determine the intensity of the

competition in a market and with it its profitability and attractiveness Therefore

the aim of the enterprise strategy should be reflected in the search for possibilities

for the reduction or use of these competitive forces relative to its own enterprise In

this regard Porter`s model is conducive to the analysis of the driving forces

working in the respective industry

Figure 2 Michael E Porter`s five forces model (Own illustration based on Porter 1979)

Industry Rivalry

Threat of New

Entrants

Bargaining Power of

Buyers

Threat of Substitute Products

and Services

Bargaining Power of Suppliers

13

Porter`s framework is a useful and frequently utilized analytical tool to describe the

foundations of industry competition

A high degree of rivalry among the existing enterprises leads to high competitive

pressure and can lower profit margins and the profitability of individual

enterprises In situations in which a large number of enterprises target similar

market segments with comparable strategies in which the market grows slowly

price is the most important differentiation factor and high exit barriers exist a

negative impact on the industryrsquos profitability is effected48

The threat of new entrants can be determined by the entry barriers of a market The

competitive pressure on existing enterprises increases with low entry barriers In

such a situation important elements of the market (eg shares of the market price

level) can change due to the entry of new market participants49

The bargaining power of buyers determines to what extent customers can influence

enterprises by the amount of consumption and the pressure on margins Important

indexes of a high degree of buyer power include high fixed costs in the industry

existence of supplements of the product or service high degree of customer

concentration customers` knowledge of production costs possibility of a reverse

integration of customers high growth rates of the market and a strong

individualization of customer demand50

The bargaining power of suppliers affects industry profitability if for example a

concentrated supplier group dominates over existing enterprises in the market

which are not important buyers for the suppliers Then the industry faces high

margin pressure by the suppliers

A threat of substitute products and services exists in particular if cheaper or higher-

quality products and services are able to reduce existing sales volumes of a market

or an enterprise51 The future sales potential of existing enterprises becomes limited

and industry competition increases

48 Porter (1985) 49 Porter (1979) Recklies (2001) 50 Recklies (2001) 51 Recklies (2001)

14

Critics of this model state that it neglects the impact of complements as a sixth

force of the industry since they may facilitate or hinder the commercialization of

certain goods However Porter argues that complements are not a force itself but

they affect profitability in the way that they influence the five forces and that `the

strategist must trace the positive or negative influence of complements on all five

forces to ascertain their impact on profitability`52

One limitation of this model is based on studies which indicate that company-

specific factors may have a more important impact on profit than industry forces53

Furthermore the model suggests relatively static and stable market structure which

makes it difficult to assess contemporary dynamic markets54

The model does not assess the impact of the parent company on its subsidiary

which is especially important in the banking sector in which parent companies

often have a strong impact on the performance of their subsidiary or branch The

parenting advantage includes the stand-alone influence through monitoring and

influence on management decisions or capital expenses Furthermore parents

create value by enhancing synergies within the group offering corporate functions

or managing portfolios55

42 Rivalry among existing competitors

In this section the intensity of competitive rivalry among existing competitors in

the German retail banking sector is discussed In this regard an analysis of industry

structure industry growth and exit barriers will be conducted

Industry structure The German banking market is characterized by a three-pillar

system which is reflected by the strict distinction between public-law banks

cooperative banks and private banks56 Each pursues different goals and is subject

to different regulations Private commercial banks pursue the goal of profit

maximization whereas saving banks serve the public contract of offering secure

52 Porter (1997)p11 53 Zack (1999) 54 Recklies (2001) 55 Goold Cambpell and Alexander (1994) 56 Gramlich (2005)

saving possibilities and loans C

interest of their members

banking market is structured as follow

Figure 3(own illustration based on Sch

Public-law banks including saving banks and state banks

total balance sheet volume of banks in Germany

do not participate in retail banking The cooperative bank sector amounts to 11

the total including cooperative banks

cooperative central banks

commercial banks including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

31 of total balance sheet volume

European Research (ZWE) 43 of experts state that the three

important or very important and

for the low number of cross

In order to describe industry rivalry among maj

retail sector the following table illustrates the number of customers per bank in

Germany

57 Engerer (2006) 58 Koumlhler (2008b)

banks 24

Private commercial banks 31

15

possibilities and loans Cooperative banks primarily serve the economic

interest of their members57 In terms of total balance sheet volume the German

banking market is structured as follows

Figure 3 Structure of the German Banking Sector(own illustration based on Schrooten 2009)

law banks including saving banks and state banks amount to 33 of the

total balance sheet volume of banks in Germany However state banks

do not participate in retail banking The cooperative bank sector amounts to 11

including cooperative banks which participate in retail ban

cooperative central banks which primarily serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

alance sheet volume According to a recent survey of the Center for

European Research (ZWE) 43 of experts state that the three-pillar system is

important or very important and 33 state that it is the critical factor responsible

cross-border mergers and acquisitions in Germany

In order to describe industry rivalry among major banks that participate in the

the following table illustrates the number of customers per bank in

Savings banks 13

State banks 20

Cooperative central banks

3Credit cooperative banks 8

Other banks 24

serve the economic

sheet volume the German

Structure of the German Banking Sector

amount to 33 of the

However state banks generally

do not participate in retail banking The cooperative bank sector amounts to 11 of

participate in retail banking and

serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks amount to

According to a recent survey of the Center for

pillar system is

33 state that it is the critical factor responsible

border mergers and acquisitions in Germany58

or banks that participate in the

the following table illustrates the number of customers per bank in

State banks 20

Cooperative central banks

16

Figure 4 Customers of German Banks at the end of 2007 in millions (own illustration based on Deutsche Bank 2008)

With approximately 50 million customers savings banks are the market leader in

the German retail banking sector Although state liability assumption for savings

banks was abolished in 2005 because the EU saw in it an unacceptable subsidy to

the disadvantage of private banks customers still associate the name `Sparkasse`

with state guarantees The specific characteristic of a saving bank is based on its

public contract in that it has to accept customers with poor credit-worthiness that

profits should be used to enhance public wealth and that the middle class should be

supplied with loans59

With approximately 30 million customers cooperative banks are the second major

player in the German retail banking sector Nearly half of these customers are

members of the cooperative banks60 In contrast to the profit maximization goal of

private commercial banks their aim is to fund their members and secure their

economic independence Although cooperative banks are economically and legally

independent in the different regions they appear uniformly as a group under the

brand of ldquoVolks- und Raiffeisenbankenrdquo With regard to growth in customer base

cooperative banks benefit from the advantage of having the regional flexibility that

59 Kruck (2008) 60 Online Raiffeisen Bank Homepage

31

4

61

118

242

30

50

0 10 20 30 40 50 60

Citibank

Hypovereinsbank

ING DiBa

Commerzbank and Dresdner Bank

Postbank and Deutsche Bank

Credit Unions (Volksbanken)

Savings Banks (Sparkassen)

17

allows for topical advertisement as well as a centralized management focus on

improving reputation61

The third group comprises the major private commercial banks including Deutsche

Bank Postbank Commerzbank and Hypovereinsbank Deutsche Bank is a leading

multinational investment bank but with relatively low market share in the retail

banking market Deutsche Bank (97 million clients) is acquiring Postbank (145

million clients) with its broad branch network in a three-step process Together

they have 242 million clients However Heino Ruland from the analyst company

Frankfurt Finanz Partner argues that Deutsche Bank might not be able to capitalize

on the financially weaker Postbank clients as Deutsche Bank is specialized in

corporate clients62 With regard to rivalry intensity and market profitability Rainer

Neske supervisory board member and head of private amp business clients of

Deutsche Bank emphasizes that the German retail banking market is too

fragmented to be highly profitable and that Deutsche Bank does not seek to

compete on the price level but defines itself through performance quality and

consultancy63

Commerzbank is the second largest private commercial bank in Germany After the

acquisition of Dresdner Bank in 2009 Commerzbank now serves more than 12

million clients (of these 11 million private and one million corporate clients) and

pursues the goal of becoming the market leader in Germany64

UniCredit Bank AG with the brand name Hypovereinsbank (HVB) is a subsidiary

of UniCredirSpA and is the third largest private commercial bank in Germany

HVB serves approximately four million clients predominantly in north Germany

and in Bavaria As its retail banking segment could only report marginal profits in

2009 speculation about a sale or acquisition in this segment has come up As the

Swedish SEB (Skandinaviska Enskilda Bank) is considering selling its German

retail segment with 174 branches and one million clients experts now regard HVB

as a major buying candidate65

61 Schwarzbauer (2009) 62 Kreiler (2008) 63 Deutsche Bank (2009) 64 Kreiler (2008) 65 Houmlpner and Nagl (2010)

18

ING DiBa AG is a subsidiary of the Dutch ING Group and serves over 6 million

clients In contrast to savings cooperative and the major private commercial

banks ING DiBa is specialized in direct banking which distributes services via

telephone the internet or post instead of through branches In Germany ING

DiBa is the leader in direct banking but there are many other direct banks such

as Comdirect (a subsidiary of Commerzbank) Volkswagen Bank or DAB Bank

(a subsidiary of HVB) Competition takes place not only among direct banks but

also between direct and branch banks For instance many saving banks have

blocked the opportunity for customers of direct banks to withdraw cash from their

automated teller machines As savings banks can only charge Euro 174 for

withdrawals via visa cards they fear that direct banks can gain market share by

offering attractive account options with a convenient wide-area ATM provision66

Targobank (former Citibank Deutschland) was acquired by the French

cooperative bank Creacutedit Mutel and now serves more than 34 million clients in

Germany in 2010 The bank is specialized in private retail customers with

branches and direct banking67

In conclusion the degree of concentration in the German retail banking market is

very low which reduces the overall profitability of this sector for two main

reasons Banks earn higher profits in concentrated markets as they obtain either

monopoly rents (structure-conduct-performance paradigm) or due to high market

shares that are gained by more efficient and profitable banks (efficient structure

hypothesis)68 As retail banking services are largely standardized product

differentiation is low and price differentiation is often the only option As public-

law banks serve other interests than profit maximization existing private banks

and MNBs that want to enter this market have a competitive disadvantage The

low switching costs of clients intensifies competition on the price level and thus

reduces the profitability of the market However brand identification and

customer relationships are also important which decreases the willingness of

clients to switch solely on the basis of price comparison In summary market

structure indicates a very high degree of rivalry among existing competitors

66 Online Financial Times Deutschland (2010) 67 Targobank (2010) 68 Havrylchyk and Jurzyk (2006) p15

19

Industry growth In this section industry growth will be examined in a dynamic

analysis of three relevant market growth indicators the future long-run

development of the German population the historical development of the number

of banks and branches in Germany and the historical development of market-

share allocation in the context of major retail banking activities

In the long-run market growth depends on the future numerical development of

the market`s customers - the German population As the growth of population

through birth and immigration is smaller than its decrease by virtue of the mortality

rate and emigration the Federal Statistical Office in Germany estimates a sharp

decline of the German population

Figure 5 Estimated Development of German Population (in millions)

(Federal Statistical Office 2009)

The Federal Statistical Office predicts that the trend of decline in population since

2003 will continue and intensify Whereas approximately 82 million people lived

in Germany in 2008 only between 65 million (average lower limit of the

population with 100000 immigrants yearly) and 70 million people (average

upper limit of the population with 200000 immigrants yearly) will reside in

Germany in 2060 Furthermore the decreasing number of births and the ageing of

the current strongly represented middle age group will lead to substantial changes

in the age structure of the population From 2008 to 2060 the proportion of people

from 65 to 80 years will increase 15 to 20 and the proportion of people over

80 years of age will increase from 5 to 14 of the population69 The

69 Federal Statistical Office (2009)

Average lower limit

Average upper limit

20

implications of the aging population for banks will be discussed in the comparison

between direct banks and BampM banks in section 66 of this thesis

The second indicator of industry growth deals with the number of banks and bank

branches in the German market The overall number of banks in Germany

decreased from 3785 in 1995 to 2300 in 2006 As retail banking usually depends

on the number branches maintained their development in Germany will be

examined

Figure 6 Development of Total Bank Branches in Germany (own illustration based on Koumlhler2008a)

Savings banks and cooperative banks have reduced the number of branches

significantly Public-sector banks (savings banks state banks etc) with 18757

branches and cooperative banks with 16028 branches in 1998 reduced the

number of branches to 14252 and 12303 respectively in 2006 Moreover the

number of branches of major commercial banks decreased from 19055 in 1998 to

8879 in 2006

The main cause for the decrease of branches is the high fixed costs which can not

be recouped from low-revenue standard products that can also be distributed

through alternative low-cost channels such as the internet70

70 Koumlhler and Land (2008)

67930 6666363186

59929 58546 5693653931

5086847244 45467 44100

40332

0

10000

20000

30000

40000

50000

60000

70000

80000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

21

As a third indicator of industry growth this paper reflects on the allocation of

market share within the retail banking sector in order to indentify trends that may

affect overall market growth This paper will reflect on market share in two major

retail banking segments - savings deposits and loans The German Central Bank

classifies the banking market in terms of savings banks cooperative banks direct

banks and credit banks The latter include universal banks which are private

commercial banks branches of foreign banks regional banks and other private

banks

This section reflects the development of market share regarding short- medium-

and long-term saving accounts and examines the allocation of loans to corporate

clients consumers (consumer loans) private households and self-employed

persons

In the period from 1998 to 2006 the market for medium-term saving deposits with

a cancellation period under three months has been dominated by saving banks (53

market share in 2006) and cooperative banks (29 market share in 2006) In the

same period the market share for long-term saving deposits with a cancellation

period above three months has also continuously been dominated by savings banks

(65 market share in 2006) and cooperative banks (24 market share in 2006)

However with regard to deposits that mature daily direct banks were able to

increase market share from approximately 15 in 1998 to over 15 in 2006

Figure 7 Market share development of saving accounts that mature daily (own illustration based on Deutsche Bundesbank 2007)

000

500

1000

1500

2000

2500

3000

3500

4000

4500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Banks

Cooperative Banks

Savings Banks

Credit Banks

22

From 1998 to 2006 market share for loans for corporate clients has been

continuously dominated by credit banks (53 market share in 2006) and savings

banks (34 market share in 2006) However this data also comprises loans for

medium and large corporations which are not part of the retail banking market

Loans for private households and self-employed persons have predominately been

granted by savings banks (39 market share in 2006) credit banks (30 market

share in 2006) and cooperative banks (25 market share in 2006) though direct

banks were able to gain some market share from 0 in 1998 up to 5 in 2006

Even more significantly direct banks were able to gain over 16 market share in

the segment of consumer loans

Figure 8 Market share development of consumer loans (own illustration based on Deutsche Bundesbank 2007)

Hence the most significant growth indicator of the retail banking market results

from the emergence of direct banks which were able to gain substantial market

share in consumper loans and deposits that mature daily

In conclusion the industry growth analysis indentifies the following growth

indicators Firstly a sharp decrease in the German population in the following

decades will reduce growth and increase industry rivalry Moreover the

demographic change increases the proportion of old people in the population

Secondly the number of branches in Germany is decreasing due to high fixed

costs of branches In order to be profitable in retail banking the existing branches

must serve a large quantity of customers which leads to strong competition

relative to market share Thirdly the development of market share allocation

000

1000

2000

3000

4000

5000

6000

7000

2002 2003 2004 2005 2006

Savings Banks

Cooperative Banks

Direct Banks

Credit Banks

23

indicates that only direct banks have experienced significant growth from 1995 to

2006

Exit barriers From a perspective of Transaction Costs Economics one can argue

that exit barriers in branch banking are high for market participants as branches

and staff are highly specific assets that lose value when used in another situation

To a large extent these assets are locked into the context of retail banking

Moreover public-law banks usually have to serve the population regardless of

whether they are profitable or not In a situation in which a bank continuously

experiences losses staff and branches may be considered as sunk costs and thus

economically `irrationalacute exit barriers However theories suggest that staff and

branches are practically valid exit barriers and cause MNCs to stay in a market71

The high degree of exit barriers intensifies the strong rivalry among existing

competitors

43 Threat of New Entrants

New entrants usually seek to gain market share while applying pressure on prices

and costs and thus increasing the investments necessary to compete An expert

survey conducted by the ZEW emphasizes the importance of entry threat to the

German retail-banking market 6666 of market experts state that new

competitors (eg foreign banks) have an important or a very important impact on

industry rivalry72

In this section the threat of new entrants to existing market participants in the

German retail banking sector is discussed In this regard this section evaluates

legal entry barriers capital requirements the necessity of large scale operations

customer switching costs and incumbency advantages of existing domestic banks

Legal entry barriers are determined by governmental regulations in the German

Banking Act (GBA) and are supervised by the Federal Supervisory Authority73

According to section 32 para 1 (1) GBA companies that intend to pursue

commercial banking transactions or financial services in Germany require written

71 Hill Hwang and Kim (1990) 72 Koumlhler and Lang (2008) 73 Bundesanstalt fuumlr Finanzdienstleistungsaufsicht (2005)

24

permission from the Federal Financial Supervisory Authority ( ldquoBundesanstalt fuumlr

Finanzdienstleistungaufsichtrdquo) The execution of banking transactions or financial

services also exists when the operator has its headquarters or primary residence

abroad but repeatedly targets companies or individuals who have their primary

residence in Germany In order to obtain the permit several requirements are

examined (eg business plan qualified management etc)

Companies from third countries which intend to conduct banking transactions and

provide financial services in Germany must establish a subsidiary (section 32 para

1 in connection with ection 33 para 1 (6) GBA) or a branch (section 32 para 1 in

connection with section 53 GBA) in Germany Companies from third countries can

apply for an exemption according to section 2 para 4 GBA if the company is

supervised utilizing international accounting standards in the home country and the

responsible authority works together with the BaFin According to section 53b

GBA companies of EEA states are allowed to establish branches (section 53b para

2) but are also free to conduct cross-border financial services without a domestic

presence (section 53b para 2a) Section 32 para 1 GBA does not apply to business

that is motivated by the initiative of the domestic individual or enterprise (so called

passive service freedom)

Representations are limited to their representative function and are not allowed to

conduct or initiate any banking business

Capital requirements are low for cross-border lending and and relatively low for

representations With high equity modes such as branches and even more so with

subsidiaries capital requirements are relatively high as capital is required for

building a broad network of facilities and offering credit to customers Capital

requirements for direct banks are relatively low compared with those of BampM

banks

The necessity of large scale operation is related to the competitive advantage of

economies of scale A company that serves the market in the context of larger

quantities benefits from lower cost per unit In retail banking profit is gained by

having a large number of clients It is expensive to build up these numbers and to

establish a distribution network to serve them This necessity relates directly to the

strategy of the bank An acquisition offers a shortcut to these facilities although the

25

costs of integration can be high as well74 A MNB may also decide to target only a

certain geographical area with certain clients and therefore do not have to enter on

a very large scale

Customer switching costs are different for each individual In general customers

can easily change their banks and open a deposit account or apply for a loan at

another bank However they have to compare the different terms for usually small

transactions to evaluate the convenience of having a bank nearby and then to

decide to terminate the relationships with their current bank75

Finally the incumbency advantages of existing banks are important entry barriers

In particular they include established brand reputation possession of the most

favorable geographical locations and market knowledge Moreover established

banks may already have exclusive contracts with SMEs76

To conclude legal entry barriers are low and particularly low for banks from the

EEA Capital requirements for entering the market are high yet as far as equity

entry modes are concerned direct banks require relatively low capital as they

distribute their services through low-cost channels Banks need to attract many

customers to be profitable but banks strategy dictates whether or not to entrance

should occur on a large scale Moreover the incumbency advantages of existing

banks constitute important entry barriers

44 Threat of Substitute Products or Services

A substitute in retail banking is a service that offers an attractive trade-off to a bank

service or product As individuals and small firms do not regularly report financial

information as do large enterprises they rely primarily on bank lending However

there are additional forms of financing in the private equity or dept market77

Many non- and near- banks provide substitute products and services Near-banks or

quasi-banks are suppliers of financial services but are not classified as credit

institutes according to section 1 GBA Near-banks such as insurance companies or

credit card organizations however do provide substitute products or services Non-

74 Hughes and MacDonald (2009) 75 Adams (2002) 76 Adams (2002) 77 Xiaoqin and Terada-Hagiwara (2003)

26

banks such as department store chains catalog companies or car producers also

provide substitute services78 For instance instead of taking out a loan in order to

pay for a product individuals or small enterprises may decide to take on a leasing

contract for a certain asset or small enterprises can obtain a trade credit as well

Individuals may decide on buying products from insurance companies instead of

putting money into a bank account

Another substitute for both direct and BampM banks is the person-to-person (p2p)

lending business a new form of borrowing and lending money that takes place in a

web-based market place In this online platform borrowers are connected to

lenders through an auction-like process in which a lender who bids to provide a

loan for the lowest interest rate will be awarded the loan contract with the

borrower A p2p company mediates between private or company borrowers and

lenders and also executes transactions between the parties similar to the role which

e-bay plays in the trade of commercial goods79 The p2p lending business does not

involve traditional banks and thus can offer superior interest rates to borrowers and

higher returns for lenders

45 Bargaining Power of Suppliers

When a supplier group is more concentrated than the industry does not primarily

depend on the industry and when the industry faces high switching costs the

supplier group has strong bargaining power and can reduce the profit potential of

an industry In the retail banking market the most relevant suppliers include human

resources suppliers of capital resources and suppliers of information and

communication technology (ICT)80 Highly talented or experienced specialists are

strongly canvassed and have strong bargaining power with respect to their salary

and working conditions However in the aftermath of the financial crisis many

banks are planning a reduction of staff According to a study of Ernst amp Young

every fifth bank intends to decrease staff and only every 10th bank is planning an

increase81 Given the current situation of the employment market the bargaining

power of employees is relatively low Suppliers of highly specialized banking ICT

78 Gabler Wirtschaftslexikon (2010) 79 Deloitte (2009) p 12 80 Buumlschgen and Boumlrner (2003) 81 Ernst amp Young (2009)

27

solutions have strong bargaining power as switching costs for these systems are

very high Moreover the higher yield requirements of shareholders can be

interpreted as supplier power

46 Bargaining Power of Buyers

In retail banking there are many buyers with relatively low transaction volumes

which weakens their bargaining power However retail banking services are

standardized and buyers can easily find similar services Switching costs have

usually been relatively high for these low volume transactions but in the age of the

internet the market is very transparent and buyers can screen different offerings

more easily This does not necessarily imply that the cheapest banking service will

be chosen automatically as customers also seek a trustworthy brand especially in

times of financial crisis Moreover there are other factors that affect the switching

cost of the individual such as the location of the branch Yet there is a tendency

towards the increasing bargaining power of buyers

This is also substantiated by the ZEW survey 7984 of market experts state that

decreasing customer loyalty and increasing price sensibility are important or very

important factors with respect to the intensity of competition in the German retail

banking sector A comparison of former and modern retail customers also indicates

that the bargaining power of retail banking service users has increased

Former Retail Customer Modern Retail Customer

Passive information seeking

behavior

Active information seeking behavior

Hardy or little informed Good to very good know-how

High customer loyality Increasing willingness to switch

Fixation on the branch Expects multi-channel banking at all times

and places

Little market transparency High price transparency

Relatively undemanding Demanding

Figure 9 Comparison of former and modern retail customers (own illustration based on Swoboda 2004)

28

5 Foreign Bank Entry Strategies in Germany

This section illustrates mode choices for foreign bank entry in Germany Based on

the hierarchical model of market entry modes82 the foreign bank has the choice of

equity and non ndash equity modes of entry An advantage of the hierarchical model is

that it allows comparing between entry modes on different levels The main

difference between equity and non ndash equity modes is the degree of resource

commitment in the foreign country As classified at the beginning of this thesis

non-equity entry refers to international banking and equity entry refers to

multinational banking

The research question of this thesis considers multinational bank entry modes

International banking however is often a first step towards multinational banking

Hence this thesis will also discuss cross-border lending and alliances as non ndash

equity entry modes The following figure illustrates a comprehensive view of

market entry modes for banks

Figure 10 A hierarchical model of entry mode choices for banks (own illustration based on Pan and Tse 2000)

82 Pan and Tse (2000)

Entry Mode Choices

Non - Equity Modes

Export

Cross Border Lending

Contractual Agreements

Alliances

Equity Modes

Equity Joint Ventures

Greenfield Investment

Branch

Subsidiary

Representation

Acquisition

Subsidiary

Branch

29

The hierarchical model illustrates the various entry mode choices for entering the

German retail banking market The creation of a common European financial

market in which banks can integrate freely is a major goal of the European Union83

The previous section of this paper indicates that entry barriers are relatively low

and that the German market is highly competitive Hence the choice of a proper

entry mode which is appropriate to the capabilities and the strategy of the bank is

even more significant Therefore the following section will reflect on the strategic

concept governing the choice of entry modes as well as the proliferation of these

entry modes in the German retail banking market

An international bank that is not interested in investing equity in the foreign

market can enter by means of cross-border lending or by forming a non-equity

alliance These non-equity entry modes can help the bank to access niche markets

or to exploit locational advantages when the bank is located near the German

border

However a retail bank defined in the beginning of this paper as a bank that

`caters for ordinary individuals and small businessacute and that seeks to enter the

German market in order to gain significant revenue from deposits and loan

business might have to consider a physical presence in the foreign country

The analysis considers entry modes that are perceived as international banking

cross-border lending and non-equity strategic alliances Furthermore the equity

modes JVs and representations will be discussed

Subsequently this section compares the market entry of a branch through

Greenfield investment with the market entry of a subsidiary by virtue of

acquisition as these modes of entry are the most common in the German retail

banking market

Finally the following question will be addressed to what extent do demographic

and technical trends favor a direct bank entry mode over a brick and mortar bank

approach in Germany

83 Fidrmuc and Hainz (2008)

30

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks (own illustration)

51 Non ndash equity modes Export ndash Cross-Border Lending

Cross-border lending is equivalent to the export entry mode and is a simple non-

equity strategy to enter a foreign market A bank which participates in cross-

border lending must assess the creditworthiness of the individual borrower as well

as the country risk which involves the possibility that these loans will be impaired

by economic or political proceedings in the foreign country84 The country risk in

Germany is rather low as it is perceived to have a solid political and economic

situation (Country Rating A2) with a stable and a very efficient business

environment (Country Rating A1)85 As a bank will only have limited access to soft

information about the creditworthiness of the borrower the availability of loans

usually decreases and the interest on loans usually increases with distance86 Soft

information for private loans includes the previous experience with the account

management of the credit user environmental facts and a judgment relative to his

employment contract87 For corporate loans soft facts may include the market

environment corporate structure management a business plan as well as

84 Hughes and McDonald (2003) 85 Online wwwtrade-safelycom (2009) 86 Agrawal and Hauswald (2007) 87 Dizil (2009)

Entry Mode Choices of MNBs

Greenfield Investment

Branch

Brick and Mortar Bank Direct Bank

Acquisition

Subsidiary

Brick and Mortar Bank Direct Bank

3

distinctive advantages and disadvantages Hence the main focus of this thesis is to

provide a broad understanding of the distinctive market entry and penetration

strategies in light of macro and micro economical developments in Germany

11 Research Objective

This thesis examines entry mode choice decisions and business model

considerations of multinational banks entering the German retail banking sector

The objective is to evaluate the affect of current market developments on their

entry mode decisions

In light of the financial crisis and the banks` rediscovery of the private individual

the German banking sector is currently experiencing a renaissance resulting in

increasing industry rivalry At the same time the processing of bank transactions

and customer services is becoming increasingly independent of the branch

distribution channel and the adoption of new technologies is substantially affecting

the allocation of retail banking services13 The technological evolution is

exemplified by the emergence of web-based direct banks which have been able to

penetrate the retail banking market with low-cost structures innovative ideas and

distinctive service thinking

Eventually the growing importance of the internet and other technological means

as distribution channels on the one hand and the remaining strong demand for

personal consultation on the other hand require a customer-oriented multi-channel

management of the banks14

This paper contrasts the two opposing ends in the field of retail banking

distribution channels It simplifies the entry mode choice between direct banks that

solely operate through the internet and brick amp mortar banks which solely operate

through a branch network Furthermore it differentiates between branch entry via

Greenfield investment and subsidiary entry via acquisition

Two major questions will be addressed

13 Deloitte (2010) 14 Welp (2009)

4

Firstly to what extent do demographic and technical developments favor a direct

bank entry mode over a brick and mortar bank approach in Germany

Secondly what affects the decision in favor of a branch entry mode via Greenfield

investment as compared to a subsidiary entry mode via acquisition in Germany

12 Structure

This thesis is systematically divided into two different complexes - a theoretical

and a practical After a classification of essential banking terms in the section 2

Section 3 then describes relevant market entry theories ndash namely the Transaction

Costs Theory and the Eclectic Theory as well as market entry strategies ndash namely

the offensive and the defensive strategies of expansion

In section 4 the German retail banking market is analyzed within the five forces

framework The goal of this examination is to evaluate market attractiveness and to

identify micro and macroeconomic developments that may shape the market in the

future

Given the theoretical framework of section 3 and the knowledge of industry

structure and trends of section 4 section 5 explores the decision driving factors of

entry mode choice In this section cross-border lending alliances joint ventures

and representations will be discussed Furthermore this section indicates what

affects the decision in favor of a branch entry mode via Greenfield investment as

compared to a subsidiary entry mode via acquisition and to what extent

demographic and technical developments favors a direct bank entry mode over a

brick and mortar bank entry mode in Germany

Section 6 introduces the SWOT analysis as well as the Service Marketing Mix and

applies these concepts to the ING - DiBa case study It illustrates how ING- DiBa

penetrated the German retail banking market with both the implementation of the

direct banking business model and the exploitation of external opportunities

Finally this thesis concludes with a summary of the major findings

5

2 Classification of Banks

21 Bank

This paper refers to banks as defined in the German Banking Act Section 1 GBA

defines financial institutes as enterprises which pursue banking transactions

insofar as the extent of these transactions requires commercial business operations

At least one of the following transactions has to be carried out security

transactions credit transactions payments transactions or other banking business

The enterprise which pursues banking transactions in Germany requires the

permission of the BaFin (Federal Institution for Finance Service Supervision)

according to section 32 GBA

22 Direct Bank

Direct banks are credit institutes which operate without a branch network and

utilize the internet and the telephone as direct communication channels through

which banking transactions are realized and marketing and customer service takes

place Thus direct banks establish cost advantages which they usually transmit in

the form of attractive terms15

23 Brick and Mortar Bank

A brick and mortar (BampM) company is a traditional street-side business that

deals with its customers face to face in an office that the company owns or rents16

A brick and mortar bank serves consumers in a physical facility as distinct from

providing online or telephone services only The term brick and mortar is not a

generally valid classification of a bank but in the jargon of e-commerce it is

frequently employed to distinguish from internet based enterprises In this thesis

the term brick and mortar bank is employed to differentiate between a direct bank

that operates through direct channels and one which operates solely through its

branch network The term brick and mortar is also distinguished from the term

click and mortar which is an expression for a form of multi-channel retailing in

15 Deutsche Bundesbank (2010) 16 Investopedia Dictionary (2010)

6

which both electronic distribution channels (click) and physical premises (mortar)

are utilized17

24 Multinational Bank

Multinational banks are defined as banks that have a physical presence in more

than one country In contrast international banks engage in cross-border operations

but do not establish a physical presence in foreign countries18

25 Retail Bank

There is no generally valid classification of retail banking in theoretical literature

or in practice19 A distinction in retail banking is often made with regard to its

target clientele In this regard some authors define retail banking as the offering of

banking and financial services to individuals and small and medium sized

enterprises20 Other sources define retail banking as the provision of these services

solely to individuals21 This paper employs the following classification of retail

banks `A retail bank is a bank that caters for ordinary individuals and small

business as distinct from large corporations Retail banking operations offer

deposit facilities lend money transfer funds and are prepared to deal in relatively

small amounts`22 In contrast to private and corporate banking retail banking

considers private clients with low to average income as well as small corporate

clients

2

Figure 1 Classification of retail banking clients

(own illustration based on Swoboda 2004)

17 Gabler Wirtschaftslexikon (2010) 18 Hersh and Weller (2002) 19 Muumlller and Joumlhnk (2005) 20 Pond (2007) FinanceWiki (2008) Tremblay and Tremblay (2007) 21 Frei Harker and Hunter (1998) Online Businessdictionarycom (2010) Investoglossarycom (2010) 22 Essvale Corporation Limited (2007)

Retail Banking

Medium and large corporate clients

Wealthy private clients

Small Corporate clients

Private clients

7

3 Market Entry Theories and Strategies

31 Transaction Costs Theory

In the transaction cost theory developed by Ronald Coase and Oliver E

Williamson a comparison of transaction costs determines the optimal form of

organization In TC Theory the entry mode decision is a tradeoff between the

control and the costs of resource commitment Entry modes vary in three major

aspects the cost of resource commitment control as the level of ownership and

environmental risks that may affect the committed resources Hence high-control

modes increase both risk and the potential return23

Williamson differentiates between ex-ante and ex-post transaction costs

Information and searching costs are incurred ex-ante in the process of collecting

market information and identifying suitable partners Negotiation and contract

costs arise ex-ante due to negotiations legal advisory and the determination of

contractual terms Monitoring costs develop ex-post for activities which serve to

control contractual obligations Conflict and enforcement costs arise ex-post due to

the different interpretation of the contract and the costs of enforcing contractual

regulations with sanctions negotiations or through court proceedings Adaption

costs are incurred due to ex-post changes in contractual agreements that become

necessary because of unpredictable developments24

TCE assumes the existence of bounded rationality and opportunism Bounded

rationality describes the limitation in human processing of information and the

planning of possible outcomes Opportunism describes the notion that humans may

act in a self-interested manner by manipulating information and being dishonest

The consequences of these assumptions are incomplete contracts and moral

hazards25 Vice versa opportunism occurs because firms can not write complete

contracts

The size of the transaction costs is determined in each case by the characteristics of

asset specificity uncertainty and frequency Asset specificity arises when the actor

in the market undertakes specific investments in order to fulfill his contractual 23 Chen and Mujtaba (2007) p322 24 Kieser and Ebers (2006) p278 25 Magill and Quenzii (1996) p11

8

obligations It refers to the degree to which long-lasting human or physical assets

are bound in a specific relationship and thus to the extent to which they provide

value in the context of a different situation26 In TCE markets can hardly solve the

problems that high uncertainty creates in combination with bounded rationality and

threats of opportunism Uncertainty includes environmental and behavioral

uncertainty Environmental uncertainty refers to political legal cultural and

economic uncertainties that may affect the success of business transactions

Behavioral uncertainty states that bounded rationality and the threat of opportunism

result in the high costs of monitoring a partner company27 If the similar

transactions are repeated frequently learning effects and economies of scale occur

and will reduce the transaction costs

32 Eclectic Theory

The eclectic theory28 (or OLI paradigm) was developed by John Dunning and is a

framework that merges different economic theories which explain foreign market

entry patterns of multinational corporations29 It states that the internationalization

of MNCs is determined by three sets of independent variables ownership

advantages (or firm- specific advantages) location advantages (or country specific

advantages) and internationalization advantages

The ownership advantage considers the competitive advantages of MNCs arising

from firm-specific characteristics such as size monopoly power economies of

scale management brand name technology and other resource capabilities30

These advantages are usually intangible assets and can be transferred at low costs31

The greater the competitive advantage of the MNC is the more likely it is able to

start or to increase its foreign production32

The location advantages arise from country specific benefits that can be divided

into three categories Firstly a host country may have economic advantages

comprising qualitative and quantitative factors such as production transports costs

26 Dietrich (1994) p18 27 Brouthers and Brouthers (2003) p1183 - 1185 28 Dunning (1980) Dunning (1988) Hill Kwang and Kim (1990) 29 Dunning (2002) 30 Forsbaeck and Oxelheim (2004) 31 Griffin and Pustay (2006) 32 Dunning (2002)

9

communication costs market size or tax incentives Secondly a host country may

offer political advantages in particular governmental policies that may influence

market entry Thirdly a host country may provide social and cultural advantages

including the psychic distance between the foreign and the domestic country as

well as language or cultural aspects that may have an impact on the market entry

decision The higher the attractions of the specific location the more likely it is that

MNCs will exploit their ownership advantage by entering the foreign market33

Because of the existence of transactions costs the internationalization incentive

advantage states that it must be profitable for the MNC to exploit these advantages

itself rather than through local companies (eg licensing)34

In economic literature the OLI paradigm has also been applied to the banking

sector In this regard ownership advantage may include easy access to a vehicle

currency Locational advantages may include country-specific regulations and

entry barriers Internationalization advantages can be information advantages and

access to local deposit bases35

Many empirical studies on the banking market have utilized the eclectic paradigm

as a basic framework For example a study of bank entry into CEE markets

concludes that the ownership advantages of foreign MNBs are strong compared to

banks in emerging markets and especially when the foreign country experiences a

banking crisis36 An application of the OLI paradigm to the Spanish banking

market has shown that bank size and multinational experience of MNBs favor

stronger commitment in the foreign country whereas distance is an entry barrier37

However theoretical literature also states that in service industries clients close to

the MNBs headquarters may be served from this location whereas clients in distant

markets require a physical presence of the MNB in the foreign country which

favors a foreign market entry with increasing distance38

33 Dunning (2002) 34 Hagen (1997) 35 Yannopoulus (1983) 36 Uiboupin and Sorg (2006) 37 Blandoacuten (1998) 38 Blondoacuten (1998) Terpstra and Yu (1988)

10

33 Strategy of Defensive Expansion

A common approach employed to explain the expansion of MNBs involves the

theory of defensive expansion which is also referred to as the acutefollow-the-

customeracute argument

This theory states that MNBs expand abroad in order to provide services for

domestic clients which are often large enterprises that have entered a foreign

market39 The provision of financial services in the foreign country usually requires

a presence at important economic centres Hence to some degree expanding

corporations impose pressure on their domestic banks to follow-up40

The term acutedefensiveacute is derived from the idea that a failure to expand may lead to a

loss of the client not only in the foreign country but also in the domestic one as

the client may associate with a foreign MNB41 Consequently MNBs which pursue

this strategy seek to prevent losses rather then to generate new profits in the foreign

market42 Furthermore the domestic bank has an incomparable competitive

advantage over banks in the foreign country with regard to the knowledge of

customer needs the respective risk of credit default as well as an interest in cross-

selling products such as financial advisory43

Due to earlier business relationships with the client the domestic bank has reduced

costs for examining the financial capacities of the respective enterprise and thus

can offer cheaper services44 Most foreign entry evidence supports the defensive

expansion theory45

A study on this theory with respect to retail banking has revealed that MNBs

sometimes expand abroad in order to provide banking services to specific

communities46

39 Trend im retail-banking koumlhler 40 Henneberger and Graf (2000) 41 Mullineux and Murinde (2003) 42 Naaborg (2007) 43 Knoop (2006) 44 Bhattacharya (1994) 45 Bhattacharya (1994) Naaborg (2007) 46 Tschoegl (1987)

11

34 Strategy of Offensive Expansion

MNBs that offensively expand abroad primarily seek to increase their customer

base both in the home and in the foreign country Firstly the establishment of

foreign branches and subsidiaries enables the MNB to expand their services to

domestic residents who benefit from the international orientation of the bank

These may include customers that have business partners in the foreign country

Secondly MNBs may target new customers in the foreign country in particular

MNEs or foreign subsidiaries of domestic enterprises As the MNB must in both

cases entice customers away from other banks the MNB has to offer attractive and

competitive conditions for their financial services47

47 Buumlschgen (1998) p604

12

4 Industry Analysis German Retail Banking Sector

41 Porter`s Five Forces

In the school of Industrial Economics the five-forces model has established itself

as a core element of industry analysis Porter`s analysis framework is built on the

following five market forces that shape the strategy of competitors threat of new

entrants threat of substitute products or services bargaining power of buyers and

suppliers as well as rivalry among existing competitors

Porterrsquos concept is based on the knowledge that the strategy of an enterprise must

orient itself to its market environment whereby the competitive strategy arises

from a differentiated understanding of the market structure and the knowledge of

how it changes The effects of these forces determine the intensity of the

competition in a market and with it its profitability and attractiveness Therefore

the aim of the enterprise strategy should be reflected in the search for possibilities

for the reduction or use of these competitive forces relative to its own enterprise In

this regard Porter`s model is conducive to the analysis of the driving forces

working in the respective industry

Figure 2 Michael E Porter`s five forces model (Own illustration based on Porter 1979)

Industry Rivalry

Threat of New

Entrants

Bargaining Power of

Buyers

Threat of Substitute Products

and Services

Bargaining Power of Suppliers

13

Porter`s framework is a useful and frequently utilized analytical tool to describe the

foundations of industry competition

A high degree of rivalry among the existing enterprises leads to high competitive

pressure and can lower profit margins and the profitability of individual

enterprises In situations in which a large number of enterprises target similar

market segments with comparable strategies in which the market grows slowly

price is the most important differentiation factor and high exit barriers exist a

negative impact on the industryrsquos profitability is effected48

The threat of new entrants can be determined by the entry barriers of a market The

competitive pressure on existing enterprises increases with low entry barriers In

such a situation important elements of the market (eg shares of the market price

level) can change due to the entry of new market participants49

The bargaining power of buyers determines to what extent customers can influence

enterprises by the amount of consumption and the pressure on margins Important

indexes of a high degree of buyer power include high fixed costs in the industry

existence of supplements of the product or service high degree of customer

concentration customers` knowledge of production costs possibility of a reverse

integration of customers high growth rates of the market and a strong

individualization of customer demand50

The bargaining power of suppliers affects industry profitability if for example a

concentrated supplier group dominates over existing enterprises in the market

which are not important buyers for the suppliers Then the industry faces high

margin pressure by the suppliers

A threat of substitute products and services exists in particular if cheaper or higher-

quality products and services are able to reduce existing sales volumes of a market

or an enterprise51 The future sales potential of existing enterprises becomes limited

and industry competition increases

48 Porter (1985) 49 Porter (1979) Recklies (2001) 50 Recklies (2001) 51 Recklies (2001)

14

Critics of this model state that it neglects the impact of complements as a sixth

force of the industry since they may facilitate or hinder the commercialization of

certain goods However Porter argues that complements are not a force itself but

they affect profitability in the way that they influence the five forces and that `the

strategist must trace the positive or negative influence of complements on all five

forces to ascertain their impact on profitability`52

One limitation of this model is based on studies which indicate that company-

specific factors may have a more important impact on profit than industry forces53

Furthermore the model suggests relatively static and stable market structure which

makes it difficult to assess contemporary dynamic markets54

The model does not assess the impact of the parent company on its subsidiary

which is especially important in the banking sector in which parent companies

often have a strong impact on the performance of their subsidiary or branch The

parenting advantage includes the stand-alone influence through monitoring and

influence on management decisions or capital expenses Furthermore parents

create value by enhancing synergies within the group offering corporate functions

or managing portfolios55

42 Rivalry among existing competitors

In this section the intensity of competitive rivalry among existing competitors in

the German retail banking sector is discussed In this regard an analysis of industry

structure industry growth and exit barriers will be conducted

Industry structure The German banking market is characterized by a three-pillar

system which is reflected by the strict distinction between public-law banks

cooperative banks and private banks56 Each pursues different goals and is subject

to different regulations Private commercial banks pursue the goal of profit

maximization whereas saving banks serve the public contract of offering secure

52 Porter (1997)p11 53 Zack (1999) 54 Recklies (2001) 55 Goold Cambpell and Alexander (1994) 56 Gramlich (2005)

saving possibilities and loans C

interest of their members

banking market is structured as follow

Figure 3(own illustration based on Sch

Public-law banks including saving banks and state banks

total balance sheet volume of banks in Germany

do not participate in retail banking The cooperative bank sector amounts to 11

the total including cooperative banks

cooperative central banks

commercial banks including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

31 of total balance sheet volume

European Research (ZWE) 43 of experts state that the three

important or very important and

for the low number of cross

In order to describe industry rivalry among maj

retail sector the following table illustrates the number of customers per bank in

Germany

57 Engerer (2006) 58 Koumlhler (2008b)

banks 24

Private commercial banks 31

15

possibilities and loans Cooperative banks primarily serve the economic

interest of their members57 In terms of total balance sheet volume the German

banking market is structured as follows

Figure 3 Structure of the German Banking Sector(own illustration based on Schrooten 2009)

law banks including saving banks and state banks amount to 33 of the

total balance sheet volume of banks in Germany However state banks

do not participate in retail banking The cooperative bank sector amounts to 11

including cooperative banks which participate in retail ban

cooperative central banks which primarily serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

alance sheet volume According to a recent survey of the Center for

European Research (ZWE) 43 of experts state that the three-pillar system is

important or very important and 33 state that it is the critical factor responsible

cross-border mergers and acquisitions in Germany

In order to describe industry rivalry among major banks that participate in the

the following table illustrates the number of customers per bank in

Savings banks 13

State banks 20

Cooperative central banks

3Credit cooperative banks 8

Other banks 24

serve the economic

sheet volume the German

Structure of the German Banking Sector

amount to 33 of the

However state banks generally

do not participate in retail banking The cooperative bank sector amounts to 11 of

participate in retail banking and

serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks amount to

According to a recent survey of the Center for

pillar system is

33 state that it is the critical factor responsible

border mergers and acquisitions in Germany58

or banks that participate in the

the following table illustrates the number of customers per bank in

State banks 20

Cooperative central banks

16

Figure 4 Customers of German Banks at the end of 2007 in millions (own illustration based on Deutsche Bank 2008)

With approximately 50 million customers savings banks are the market leader in

the German retail banking sector Although state liability assumption for savings

banks was abolished in 2005 because the EU saw in it an unacceptable subsidy to

the disadvantage of private banks customers still associate the name `Sparkasse`

with state guarantees The specific characteristic of a saving bank is based on its

public contract in that it has to accept customers with poor credit-worthiness that

profits should be used to enhance public wealth and that the middle class should be

supplied with loans59

With approximately 30 million customers cooperative banks are the second major

player in the German retail banking sector Nearly half of these customers are

members of the cooperative banks60 In contrast to the profit maximization goal of

private commercial banks their aim is to fund their members and secure their

economic independence Although cooperative banks are economically and legally

independent in the different regions they appear uniformly as a group under the

brand of ldquoVolks- und Raiffeisenbankenrdquo With regard to growth in customer base

cooperative banks benefit from the advantage of having the regional flexibility that

59 Kruck (2008) 60 Online Raiffeisen Bank Homepage

31

4

61

118

242

30

50

0 10 20 30 40 50 60

Citibank

Hypovereinsbank

ING DiBa

Commerzbank and Dresdner Bank

Postbank and Deutsche Bank

Credit Unions (Volksbanken)

Savings Banks (Sparkassen)

17

allows for topical advertisement as well as a centralized management focus on

improving reputation61

The third group comprises the major private commercial banks including Deutsche

Bank Postbank Commerzbank and Hypovereinsbank Deutsche Bank is a leading

multinational investment bank but with relatively low market share in the retail

banking market Deutsche Bank (97 million clients) is acquiring Postbank (145

million clients) with its broad branch network in a three-step process Together

they have 242 million clients However Heino Ruland from the analyst company

Frankfurt Finanz Partner argues that Deutsche Bank might not be able to capitalize

on the financially weaker Postbank clients as Deutsche Bank is specialized in

corporate clients62 With regard to rivalry intensity and market profitability Rainer

Neske supervisory board member and head of private amp business clients of

Deutsche Bank emphasizes that the German retail banking market is too

fragmented to be highly profitable and that Deutsche Bank does not seek to

compete on the price level but defines itself through performance quality and

consultancy63

Commerzbank is the second largest private commercial bank in Germany After the

acquisition of Dresdner Bank in 2009 Commerzbank now serves more than 12

million clients (of these 11 million private and one million corporate clients) and

pursues the goal of becoming the market leader in Germany64

UniCredit Bank AG with the brand name Hypovereinsbank (HVB) is a subsidiary

of UniCredirSpA and is the third largest private commercial bank in Germany

HVB serves approximately four million clients predominantly in north Germany

and in Bavaria As its retail banking segment could only report marginal profits in

2009 speculation about a sale or acquisition in this segment has come up As the

Swedish SEB (Skandinaviska Enskilda Bank) is considering selling its German

retail segment with 174 branches and one million clients experts now regard HVB

as a major buying candidate65

61 Schwarzbauer (2009) 62 Kreiler (2008) 63 Deutsche Bank (2009) 64 Kreiler (2008) 65 Houmlpner and Nagl (2010)

18

ING DiBa AG is a subsidiary of the Dutch ING Group and serves over 6 million

clients In contrast to savings cooperative and the major private commercial

banks ING DiBa is specialized in direct banking which distributes services via

telephone the internet or post instead of through branches In Germany ING

DiBa is the leader in direct banking but there are many other direct banks such

as Comdirect (a subsidiary of Commerzbank) Volkswagen Bank or DAB Bank

(a subsidiary of HVB) Competition takes place not only among direct banks but

also between direct and branch banks For instance many saving banks have

blocked the opportunity for customers of direct banks to withdraw cash from their

automated teller machines As savings banks can only charge Euro 174 for

withdrawals via visa cards they fear that direct banks can gain market share by

offering attractive account options with a convenient wide-area ATM provision66

Targobank (former Citibank Deutschland) was acquired by the French

cooperative bank Creacutedit Mutel and now serves more than 34 million clients in

Germany in 2010 The bank is specialized in private retail customers with

branches and direct banking67

In conclusion the degree of concentration in the German retail banking market is

very low which reduces the overall profitability of this sector for two main

reasons Banks earn higher profits in concentrated markets as they obtain either

monopoly rents (structure-conduct-performance paradigm) or due to high market

shares that are gained by more efficient and profitable banks (efficient structure

hypothesis)68 As retail banking services are largely standardized product

differentiation is low and price differentiation is often the only option As public-

law banks serve other interests than profit maximization existing private banks

and MNBs that want to enter this market have a competitive disadvantage The

low switching costs of clients intensifies competition on the price level and thus

reduces the profitability of the market However brand identification and

customer relationships are also important which decreases the willingness of

clients to switch solely on the basis of price comparison In summary market

structure indicates a very high degree of rivalry among existing competitors

66 Online Financial Times Deutschland (2010) 67 Targobank (2010) 68 Havrylchyk and Jurzyk (2006) p15

19

Industry growth In this section industry growth will be examined in a dynamic

analysis of three relevant market growth indicators the future long-run

development of the German population the historical development of the number

of banks and branches in Germany and the historical development of market-

share allocation in the context of major retail banking activities

In the long-run market growth depends on the future numerical development of

the market`s customers - the German population As the growth of population

through birth and immigration is smaller than its decrease by virtue of the mortality

rate and emigration the Federal Statistical Office in Germany estimates a sharp

decline of the German population

Figure 5 Estimated Development of German Population (in millions)

(Federal Statistical Office 2009)

The Federal Statistical Office predicts that the trend of decline in population since

2003 will continue and intensify Whereas approximately 82 million people lived

in Germany in 2008 only between 65 million (average lower limit of the

population with 100000 immigrants yearly) and 70 million people (average

upper limit of the population with 200000 immigrants yearly) will reside in

Germany in 2060 Furthermore the decreasing number of births and the ageing of

the current strongly represented middle age group will lead to substantial changes

in the age structure of the population From 2008 to 2060 the proportion of people

from 65 to 80 years will increase 15 to 20 and the proportion of people over

80 years of age will increase from 5 to 14 of the population69 The

69 Federal Statistical Office (2009)

Average lower limit

Average upper limit

20

implications of the aging population for banks will be discussed in the comparison

between direct banks and BampM banks in section 66 of this thesis

The second indicator of industry growth deals with the number of banks and bank

branches in the German market The overall number of banks in Germany

decreased from 3785 in 1995 to 2300 in 2006 As retail banking usually depends

on the number branches maintained their development in Germany will be

examined

Figure 6 Development of Total Bank Branches in Germany (own illustration based on Koumlhler2008a)

Savings banks and cooperative banks have reduced the number of branches

significantly Public-sector banks (savings banks state banks etc) with 18757

branches and cooperative banks with 16028 branches in 1998 reduced the

number of branches to 14252 and 12303 respectively in 2006 Moreover the

number of branches of major commercial banks decreased from 19055 in 1998 to

8879 in 2006

The main cause for the decrease of branches is the high fixed costs which can not

be recouped from low-revenue standard products that can also be distributed

through alternative low-cost channels such as the internet70

70 Koumlhler and Land (2008)

67930 6666363186

59929 58546 5693653931

5086847244 45467 44100

40332

0

10000

20000

30000

40000

50000

60000

70000

80000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

21

As a third indicator of industry growth this paper reflects on the allocation of

market share within the retail banking sector in order to indentify trends that may

affect overall market growth This paper will reflect on market share in two major

retail banking segments - savings deposits and loans The German Central Bank

classifies the banking market in terms of savings banks cooperative banks direct

banks and credit banks The latter include universal banks which are private

commercial banks branches of foreign banks regional banks and other private

banks

This section reflects the development of market share regarding short- medium-

and long-term saving accounts and examines the allocation of loans to corporate

clients consumers (consumer loans) private households and self-employed

persons

In the period from 1998 to 2006 the market for medium-term saving deposits with

a cancellation period under three months has been dominated by saving banks (53

market share in 2006) and cooperative banks (29 market share in 2006) In the

same period the market share for long-term saving deposits with a cancellation

period above three months has also continuously been dominated by savings banks

(65 market share in 2006) and cooperative banks (24 market share in 2006)

However with regard to deposits that mature daily direct banks were able to

increase market share from approximately 15 in 1998 to over 15 in 2006

Figure 7 Market share development of saving accounts that mature daily (own illustration based on Deutsche Bundesbank 2007)

000

500

1000

1500

2000

2500

3000

3500

4000

4500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Banks

Cooperative Banks

Savings Banks

Credit Banks

22

From 1998 to 2006 market share for loans for corporate clients has been

continuously dominated by credit banks (53 market share in 2006) and savings

banks (34 market share in 2006) However this data also comprises loans for

medium and large corporations which are not part of the retail banking market

Loans for private households and self-employed persons have predominately been

granted by savings banks (39 market share in 2006) credit banks (30 market

share in 2006) and cooperative banks (25 market share in 2006) though direct

banks were able to gain some market share from 0 in 1998 up to 5 in 2006

Even more significantly direct banks were able to gain over 16 market share in

the segment of consumer loans

Figure 8 Market share development of consumer loans (own illustration based on Deutsche Bundesbank 2007)

Hence the most significant growth indicator of the retail banking market results

from the emergence of direct banks which were able to gain substantial market

share in consumper loans and deposits that mature daily

In conclusion the industry growth analysis indentifies the following growth

indicators Firstly a sharp decrease in the German population in the following

decades will reduce growth and increase industry rivalry Moreover the

demographic change increases the proportion of old people in the population

Secondly the number of branches in Germany is decreasing due to high fixed

costs of branches In order to be profitable in retail banking the existing branches

must serve a large quantity of customers which leads to strong competition

relative to market share Thirdly the development of market share allocation

000

1000

2000

3000

4000

5000

6000

7000

2002 2003 2004 2005 2006

Savings Banks

Cooperative Banks

Direct Banks

Credit Banks

23

indicates that only direct banks have experienced significant growth from 1995 to

2006

Exit barriers From a perspective of Transaction Costs Economics one can argue

that exit barriers in branch banking are high for market participants as branches

and staff are highly specific assets that lose value when used in another situation

To a large extent these assets are locked into the context of retail banking

Moreover public-law banks usually have to serve the population regardless of

whether they are profitable or not In a situation in which a bank continuously

experiences losses staff and branches may be considered as sunk costs and thus

economically `irrationalacute exit barriers However theories suggest that staff and

branches are practically valid exit barriers and cause MNCs to stay in a market71

The high degree of exit barriers intensifies the strong rivalry among existing

competitors

43 Threat of New Entrants

New entrants usually seek to gain market share while applying pressure on prices

and costs and thus increasing the investments necessary to compete An expert

survey conducted by the ZEW emphasizes the importance of entry threat to the

German retail-banking market 6666 of market experts state that new

competitors (eg foreign banks) have an important or a very important impact on

industry rivalry72

In this section the threat of new entrants to existing market participants in the

German retail banking sector is discussed In this regard this section evaluates

legal entry barriers capital requirements the necessity of large scale operations

customer switching costs and incumbency advantages of existing domestic banks

Legal entry barriers are determined by governmental regulations in the German

Banking Act (GBA) and are supervised by the Federal Supervisory Authority73

According to section 32 para 1 (1) GBA companies that intend to pursue

commercial banking transactions or financial services in Germany require written

71 Hill Hwang and Kim (1990) 72 Koumlhler and Lang (2008) 73 Bundesanstalt fuumlr Finanzdienstleistungsaufsicht (2005)

24

permission from the Federal Financial Supervisory Authority ( ldquoBundesanstalt fuumlr

Finanzdienstleistungaufsichtrdquo) The execution of banking transactions or financial

services also exists when the operator has its headquarters or primary residence

abroad but repeatedly targets companies or individuals who have their primary

residence in Germany In order to obtain the permit several requirements are

examined (eg business plan qualified management etc)

Companies from third countries which intend to conduct banking transactions and

provide financial services in Germany must establish a subsidiary (section 32 para

1 in connection with ection 33 para 1 (6) GBA) or a branch (section 32 para 1 in

connection with section 53 GBA) in Germany Companies from third countries can

apply for an exemption according to section 2 para 4 GBA if the company is

supervised utilizing international accounting standards in the home country and the

responsible authority works together with the BaFin According to section 53b

GBA companies of EEA states are allowed to establish branches (section 53b para

2) but are also free to conduct cross-border financial services without a domestic

presence (section 53b para 2a) Section 32 para 1 GBA does not apply to business

that is motivated by the initiative of the domestic individual or enterprise (so called

passive service freedom)

Representations are limited to their representative function and are not allowed to

conduct or initiate any banking business

Capital requirements are low for cross-border lending and and relatively low for

representations With high equity modes such as branches and even more so with

subsidiaries capital requirements are relatively high as capital is required for

building a broad network of facilities and offering credit to customers Capital

requirements for direct banks are relatively low compared with those of BampM

banks

The necessity of large scale operation is related to the competitive advantage of

economies of scale A company that serves the market in the context of larger

quantities benefits from lower cost per unit In retail banking profit is gained by

having a large number of clients It is expensive to build up these numbers and to

establish a distribution network to serve them This necessity relates directly to the

strategy of the bank An acquisition offers a shortcut to these facilities although the

25

costs of integration can be high as well74 A MNB may also decide to target only a

certain geographical area with certain clients and therefore do not have to enter on

a very large scale

Customer switching costs are different for each individual In general customers

can easily change their banks and open a deposit account or apply for a loan at

another bank However they have to compare the different terms for usually small

transactions to evaluate the convenience of having a bank nearby and then to

decide to terminate the relationships with their current bank75

Finally the incumbency advantages of existing banks are important entry barriers

In particular they include established brand reputation possession of the most

favorable geographical locations and market knowledge Moreover established

banks may already have exclusive contracts with SMEs76

To conclude legal entry barriers are low and particularly low for banks from the

EEA Capital requirements for entering the market are high yet as far as equity

entry modes are concerned direct banks require relatively low capital as they

distribute their services through low-cost channels Banks need to attract many

customers to be profitable but banks strategy dictates whether or not to entrance

should occur on a large scale Moreover the incumbency advantages of existing

banks constitute important entry barriers

44 Threat of Substitute Products or Services

A substitute in retail banking is a service that offers an attractive trade-off to a bank

service or product As individuals and small firms do not regularly report financial

information as do large enterprises they rely primarily on bank lending However

there are additional forms of financing in the private equity or dept market77

Many non- and near- banks provide substitute products and services Near-banks or

quasi-banks are suppliers of financial services but are not classified as credit

institutes according to section 1 GBA Near-banks such as insurance companies or

credit card organizations however do provide substitute products or services Non-

74 Hughes and MacDonald (2009) 75 Adams (2002) 76 Adams (2002) 77 Xiaoqin and Terada-Hagiwara (2003)

26

banks such as department store chains catalog companies or car producers also

provide substitute services78 For instance instead of taking out a loan in order to

pay for a product individuals or small enterprises may decide to take on a leasing

contract for a certain asset or small enterprises can obtain a trade credit as well

Individuals may decide on buying products from insurance companies instead of

putting money into a bank account

Another substitute for both direct and BampM banks is the person-to-person (p2p)

lending business a new form of borrowing and lending money that takes place in a

web-based market place In this online platform borrowers are connected to

lenders through an auction-like process in which a lender who bids to provide a

loan for the lowest interest rate will be awarded the loan contract with the

borrower A p2p company mediates between private or company borrowers and

lenders and also executes transactions between the parties similar to the role which

e-bay plays in the trade of commercial goods79 The p2p lending business does not

involve traditional banks and thus can offer superior interest rates to borrowers and

higher returns for lenders

45 Bargaining Power of Suppliers

When a supplier group is more concentrated than the industry does not primarily

depend on the industry and when the industry faces high switching costs the

supplier group has strong bargaining power and can reduce the profit potential of

an industry In the retail banking market the most relevant suppliers include human

resources suppliers of capital resources and suppliers of information and

communication technology (ICT)80 Highly talented or experienced specialists are

strongly canvassed and have strong bargaining power with respect to their salary

and working conditions However in the aftermath of the financial crisis many

banks are planning a reduction of staff According to a study of Ernst amp Young

every fifth bank intends to decrease staff and only every 10th bank is planning an

increase81 Given the current situation of the employment market the bargaining

power of employees is relatively low Suppliers of highly specialized banking ICT

78 Gabler Wirtschaftslexikon (2010) 79 Deloitte (2009) p 12 80 Buumlschgen and Boumlrner (2003) 81 Ernst amp Young (2009)

27

solutions have strong bargaining power as switching costs for these systems are

very high Moreover the higher yield requirements of shareholders can be

interpreted as supplier power

46 Bargaining Power of Buyers

In retail banking there are many buyers with relatively low transaction volumes

which weakens their bargaining power However retail banking services are

standardized and buyers can easily find similar services Switching costs have

usually been relatively high for these low volume transactions but in the age of the

internet the market is very transparent and buyers can screen different offerings

more easily This does not necessarily imply that the cheapest banking service will

be chosen automatically as customers also seek a trustworthy brand especially in

times of financial crisis Moreover there are other factors that affect the switching

cost of the individual such as the location of the branch Yet there is a tendency

towards the increasing bargaining power of buyers

This is also substantiated by the ZEW survey 7984 of market experts state that

decreasing customer loyalty and increasing price sensibility are important or very

important factors with respect to the intensity of competition in the German retail

banking sector A comparison of former and modern retail customers also indicates

that the bargaining power of retail banking service users has increased

Former Retail Customer Modern Retail Customer

Passive information seeking

behavior

Active information seeking behavior

Hardy or little informed Good to very good know-how

High customer loyality Increasing willingness to switch

Fixation on the branch Expects multi-channel banking at all times

and places

Little market transparency High price transparency

Relatively undemanding Demanding

Figure 9 Comparison of former and modern retail customers (own illustration based on Swoboda 2004)

28

5 Foreign Bank Entry Strategies in Germany

This section illustrates mode choices for foreign bank entry in Germany Based on

the hierarchical model of market entry modes82 the foreign bank has the choice of

equity and non ndash equity modes of entry An advantage of the hierarchical model is

that it allows comparing between entry modes on different levels The main

difference between equity and non ndash equity modes is the degree of resource

commitment in the foreign country As classified at the beginning of this thesis

non-equity entry refers to international banking and equity entry refers to

multinational banking

The research question of this thesis considers multinational bank entry modes

International banking however is often a first step towards multinational banking

Hence this thesis will also discuss cross-border lending and alliances as non ndash

equity entry modes The following figure illustrates a comprehensive view of

market entry modes for banks

Figure 10 A hierarchical model of entry mode choices for banks (own illustration based on Pan and Tse 2000)

82 Pan and Tse (2000)

Entry Mode Choices

Non - Equity Modes

Export

Cross Border Lending

Contractual Agreements

Alliances

Equity Modes

Equity Joint Ventures

Greenfield Investment

Branch

Subsidiary

Representation

Acquisition

Subsidiary

Branch

29

The hierarchical model illustrates the various entry mode choices for entering the

German retail banking market The creation of a common European financial

market in which banks can integrate freely is a major goal of the European Union83

The previous section of this paper indicates that entry barriers are relatively low

and that the German market is highly competitive Hence the choice of a proper

entry mode which is appropriate to the capabilities and the strategy of the bank is

even more significant Therefore the following section will reflect on the strategic

concept governing the choice of entry modes as well as the proliferation of these

entry modes in the German retail banking market

An international bank that is not interested in investing equity in the foreign

market can enter by means of cross-border lending or by forming a non-equity

alliance These non-equity entry modes can help the bank to access niche markets

or to exploit locational advantages when the bank is located near the German

border

However a retail bank defined in the beginning of this paper as a bank that

`caters for ordinary individuals and small businessacute and that seeks to enter the

German market in order to gain significant revenue from deposits and loan

business might have to consider a physical presence in the foreign country

The analysis considers entry modes that are perceived as international banking

cross-border lending and non-equity strategic alliances Furthermore the equity

modes JVs and representations will be discussed

Subsequently this section compares the market entry of a branch through

Greenfield investment with the market entry of a subsidiary by virtue of

acquisition as these modes of entry are the most common in the German retail

banking market

Finally the following question will be addressed to what extent do demographic

and technical trends favor a direct bank entry mode over a brick and mortar bank

approach in Germany

83 Fidrmuc and Hainz (2008)

30

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks (own illustration)

51 Non ndash equity modes Export ndash Cross-Border Lending

Cross-border lending is equivalent to the export entry mode and is a simple non-

equity strategy to enter a foreign market A bank which participates in cross-

border lending must assess the creditworthiness of the individual borrower as well

as the country risk which involves the possibility that these loans will be impaired

by economic or political proceedings in the foreign country84 The country risk in

Germany is rather low as it is perceived to have a solid political and economic

situation (Country Rating A2) with a stable and a very efficient business

environment (Country Rating A1)85 As a bank will only have limited access to soft

information about the creditworthiness of the borrower the availability of loans

usually decreases and the interest on loans usually increases with distance86 Soft

information for private loans includes the previous experience with the account

management of the credit user environmental facts and a judgment relative to his

employment contract87 For corporate loans soft facts may include the market

environment corporate structure management a business plan as well as

84 Hughes and McDonald (2003) 85 Online wwwtrade-safelycom (2009) 86 Agrawal and Hauswald (2007) 87 Dizil (2009)

Entry Mode Choices of MNBs

Greenfield Investment

Branch

Brick and Mortar Bank Direct Bank

Acquisition

Subsidiary

Brick and Mortar Bank Direct Bank

4

Firstly to what extent do demographic and technical developments favor a direct

bank entry mode over a brick and mortar bank approach in Germany

Secondly what affects the decision in favor of a branch entry mode via Greenfield

investment as compared to a subsidiary entry mode via acquisition in Germany

12 Structure

This thesis is systematically divided into two different complexes - a theoretical

and a practical After a classification of essential banking terms in the section 2

Section 3 then describes relevant market entry theories ndash namely the Transaction

Costs Theory and the Eclectic Theory as well as market entry strategies ndash namely

the offensive and the defensive strategies of expansion

In section 4 the German retail banking market is analyzed within the five forces

framework The goal of this examination is to evaluate market attractiveness and to

identify micro and macroeconomic developments that may shape the market in the

future

Given the theoretical framework of section 3 and the knowledge of industry

structure and trends of section 4 section 5 explores the decision driving factors of

entry mode choice In this section cross-border lending alliances joint ventures

and representations will be discussed Furthermore this section indicates what

affects the decision in favor of a branch entry mode via Greenfield investment as

compared to a subsidiary entry mode via acquisition and to what extent

demographic and technical developments favors a direct bank entry mode over a

brick and mortar bank entry mode in Germany

Section 6 introduces the SWOT analysis as well as the Service Marketing Mix and

applies these concepts to the ING - DiBa case study It illustrates how ING- DiBa

penetrated the German retail banking market with both the implementation of the

direct banking business model and the exploitation of external opportunities

Finally this thesis concludes with a summary of the major findings

5

2 Classification of Banks

21 Bank

This paper refers to banks as defined in the German Banking Act Section 1 GBA

defines financial institutes as enterprises which pursue banking transactions

insofar as the extent of these transactions requires commercial business operations

At least one of the following transactions has to be carried out security

transactions credit transactions payments transactions or other banking business

The enterprise which pursues banking transactions in Germany requires the

permission of the BaFin (Federal Institution for Finance Service Supervision)

according to section 32 GBA

22 Direct Bank

Direct banks are credit institutes which operate without a branch network and

utilize the internet and the telephone as direct communication channels through

which banking transactions are realized and marketing and customer service takes

place Thus direct banks establish cost advantages which they usually transmit in

the form of attractive terms15

23 Brick and Mortar Bank

A brick and mortar (BampM) company is a traditional street-side business that

deals with its customers face to face in an office that the company owns or rents16

A brick and mortar bank serves consumers in a physical facility as distinct from

providing online or telephone services only The term brick and mortar is not a

generally valid classification of a bank but in the jargon of e-commerce it is

frequently employed to distinguish from internet based enterprises In this thesis

the term brick and mortar bank is employed to differentiate between a direct bank

that operates through direct channels and one which operates solely through its

branch network The term brick and mortar is also distinguished from the term

click and mortar which is an expression for a form of multi-channel retailing in

15 Deutsche Bundesbank (2010) 16 Investopedia Dictionary (2010)

6

which both electronic distribution channels (click) and physical premises (mortar)

are utilized17

24 Multinational Bank

Multinational banks are defined as banks that have a physical presence in more

than one country In contrast international banks engage in cross-border operations

but do not establish a physical presence in foreign countries18

25 Retail Bank

There is no generally valid classification of retail banking in theoretical literature

or in practice19 A distinction in retail banking is often made with regard to its

target clientele In this regard some authors define retail banking as the offering of

banking and financial services to individuals and small and medium sized

enterprises20 Other sources define retail banking as the provision of these services

solely to individuals21 This paper employs the following classification of retail

banks `A retail bank is a bank that caters for ordinary individuals and small

business as distinct from large corporations Retail banking operations offer

deposit facilities lend money transfer funds and are prepared to deal in relatively

small amounts`22 In contrast to private and corporate banking retail banking

considers private clients with low to average income as well as small corporate

clients

2

Figure 1 Classification of retail banking clients

(own illustration based on Swoboda 2004)

17 Gabler Wirtschaftslexikon (2010) 18 Hersh and Weller (2002) 19 Muumlller and Joumlhnk (2005) 20 Pond (2007) FinanceWiki (2008) Tremblay and Tremblay (2007) 21 Frei Harker and Hunter (1998) Online Businessdictionarycom (2010) Investoglossarycom (2010) 22 Essvale Corporation Limited (2007)

Retail Banking

Medium and large corporate clients

Wealthy private clients

Small Corporate clients

Private clients

7

3 Market Entry Theories and Strategies

31 Transaction Costs Theory

In the transaction cost theory developed by Ronald Coase and Oliver E

Williamson a comparison of transaction costs determines the optimal form of

organization In TC Theory the entry mode decision is a tradeoff between the

control and the costs of resource commitment Entry modes vary in three major

aspects the cost of resource commitment control as the level of ownership and

environmental risks that may affect the committed resources Hence high-control

modes increase both risk and the potential return23

Williamson differentiates between ex-ante and ex-post transaction costs

Information and searching costs are incurred ex-ante in the process of collecting

market information and identifying suitable partners Negotiation and contract

costs arise ex-ante due to negotiations legal advisory and the determination of

contractual terms Monitoring costs develop ex-post for activities which serve to

control contractual obligations Conflict and enforcement costs arise ex-post due to

the different interpretation of the contract and the costs of enforcing contractual

regulations with sanctions negotiations or through court proceedings Adaption

costs are incurred due to ex-post changes in contractual agreements that become

necessary because of unpredictable developments24

TCE assumes the existence of bounded rationality and opportunism Bounded

rationality describes the limitation in human processing of information and the

planning of possible outcomes Opportunism describes the notion that humans may

act in a self-interested manner by manipulating information and being dishonest

The consequences of these assumptions are incomplete contracts and moral

hazards25 Vice versa opportunism occurs because firms can not write complete

contracts

The size of the transaction costs is determined in each case by the characteristics of

asset specificity uncertainty and frequency Asset specificity arises when the actor

in the market undertakes specific investments in order to fulfill his contractual 23 Chen and Mujtaba (2007) p322 24 Kieser and Ebers (2006) p278 25 Magill and Quenzii (1996) p11

8

obligations It refers to the degree to which long-lasting human or physical assets

are bound in a specific relationship and thus to the extent to which they provide

value in the context of a different situation26 In TCE markets can hardly solve the

problems that high uncertainty creates in combination with bounded rationality and

threats of opportunism Uncertainty includes environmental and behavioral

uncertainty Environmental uncertainty refers to political legal cultural and

economic uncertainties that may affect the success of business transactions

Behavioral uncertainty states that bounded rationality and the threat of opportunism

result in the high costs of monitoring a partner company27 If the similar

transactions are repeated frequently learning effects and economies of scale occur

and will reduce the transaction costs

32 Eclectic Theory

The eclectic theory28 (or OLI paradigm) was developed by John Dunning and is a

framework that merges different economic theories which explain foreign market

entry patterns of multinational corporations29 It states that the internationalization

of MNCs is determined by three sets of independent variables ownership

advantages (or firm- specific advantages) location advantages (or country specific

advantages) and internationalization advantages

The ownership advantage considers the competitive advantages of MNCs arising

from firm-specific characteristics such as size monopoly power economies of

scale management brand name technology and other resource capabilities30

These advantages are usually intangible assets and can be transferred at low costs31

The greater the competitive advantage of the MNC is the more likely it is able to

start or to increase its foreign production32

The location advantages arise from country specific benefits that can be divided

into three categories Firstly a host country may have economic advantages

comprising qualitative and quantitative factors such as production transports costs

26 Dietrich (1994) p18 27 Brouthers and Brouthers (2003) p1183 - 1185 28 Dunning (1980) Dunning (1988) Hill Kwang and Kim (1990) 29 Dunning (2002) 30 Forsbaeck and Oxelheim (2004) 31 Griffin and Pustay (2006) 32 Dunning (2002)

9

communication costs market size or tax incentives Secondly a host country may

offer political advantages in particular governmental policies that may influence

market entry Thirdly a host country may provide social and cultural advantages

including the psychic distance between the foreign and the domestic country as

well as language or cultural aspects that may have an impact on the market entry

decision The higher the attractions of the specific location the more likely it is that

MNCs will exploit their ownership advantage by entering the foreign market33

Because of the existence of transactions costs the internationalization incentive

advantage states that it must be profitable for the MNC to exploit these advantages

itself rather than through local companies (eg licensing)34

In economic literature the OLI paradigm has also been applied to the banking

sector In this regard ownership advantage may include easy access to a vehicle

currency Locational advantages may include country-specific regulations and

entry barriers Internationalization advantages can be information advantages and

access to local deposit bases35

Many empirical studies on the banking market have utilized the eclectic paradigm

as a basic framework For example a study of bank entry into CEE markets

concludes that the ownership advantages of foreign MNBs are strong compared to

banks in emerging markets and especially when the foreign country experiences a

banking crisis36 An application of the OLI paradigm to the Spanish banking

market has shown that bank size and multinational experience of MNBs favor

stronger commitment in the foreign country whereas distance is an entry barrier37

However theoretical literature also states that in service industries clients close to

the MNBs headquarters may be served from this location whereas clients in distant

markets require a physical presence of the MNB in the foreign country which

favors a foreign market entry with increasing distance38

33 Dunning (2002) 34 Hagen (1997) 35 Yannopoulus (1983) 36 Uiboupin and Sorg (2006) 37 Blandoacuten (1998) 38 Blondoacuten (1998) Terpstra and Yu (1988)

10

33 Strategy of Defensive Expansion

A common approach employed to explain the expansion of MNBs involves the

theory of defensive expansion which is also referred to as the acutefollow-the-

customeracute argument

This theory states that MNBs expand abroad in order to provide services for

domestic clients which are often large enterprises that have entered a foreign

market39 The provision of financial services in the foreign country usually requires

a presence at important economic centres Hence to some degree expanding

corporations impose pressure on their domestic banks to follow-up40

The term acutedefensiveacute is derived from the idea that a failure to expand may lead to a

loss of the client not only in the foreign country but also in the domestic one as

the client may associate with a foreign MNB41 Consequently MNBs which pursue

this strategy seek to prevent losses rather then to generate new profits in the foreign

market42 Furthermore the domestic bank has an incomparable competitive

advantage over banks in the foreign country with regard to the knowledge of

customer needs the respective risk of credit default as well as an interest in cross-

selling products such as financial advisory43

Due to earlier business relationships with the client the domestic bank has reduced

costs for examining the financial capacities of the respective enterprise and thus

can offer cheaper services44 Most foreign entry evidence supports the defensive

expansion theory45

A study on this theory with respect to retail banking has revealed that MNBs

sometimes expand abroad in order to provide banking services to specific

communities46

39 Trend im retail-banking koumlhler 40 Henneberger and Graf (2000) 41 Mullineux and Murinde (2003) 42 Naaborg (2007) 43 Knoop (2006) 44 Bhattacharya (1994) 45 Bhattacharya (1994) Naaborg (2007) 46 Tschoegl (1987)

11

34 Strategy of Offensive Expansion

MNBs that offensively expand abroad primarily seek to increase their customer

base both in the home and in the foreign country Firstly the establishment of

foreign branches and subsidiaries enables the MNB to expand their services to

domestic residents who benefit from the international orientation of the bank

These may include customers that have business partners in the foreign country

Secondly MNBs may target new customers in the foreign country in particular

MNEs or foreign subsidiaries of domestic enterprises As the MNB must in both

cases entice customers away from other banks the MNB has to offer attractive and

competitive conditions for their financial services47

47 Buumlschgen (1998) p604

12

4 Industry Analysis German Retail Banking Sector

41 Porter`s Five Forces

In the school of Industrial Economics the five-forces model has established itself

as a core element of industry analysis Porter`s analysis framework is built on the

following five market forces that shape the strategy of competitors threat of new

entrants threat of substitute products or services bargaining power of buyers and

suppliers as well as rivalry among existing competitors

Porterrsquos concept is based on the knowledge that the strategy of an enterprise must

orient itself to its market environment whereby the competitive strategy arises

from a differentiated understanding of the market structure and the knowledge of

how it changes The effects of these forces determine the intensity of the

competition in a market and with it its profitability and attractiveness Therefore

the aim of the enterprise strategy should be reflected in the search for possibilities

for the reduction or use of these competitive forces relative to its own enterprise In

this regard Porter`s model is conducive to the analysis of the driving forces

working in the respective industry

Figure 2 Michael E Porter`s five forces model (Own illustration based on Porter 1979)

Industry Rivalry

Threat of New

Entrants

Bargaining Power of

Buyers

Threat of Substitute Products

and Services

Bargaining Power of Suppliers

13

Porter`s framework is a useful and frequently utilized analytical tool to describe the

foundations of industry competition

A high degree of rivalry among the existing enterprises leads to high competitive

pressure and can lower profit margins and the profitability of individual

enterprises In situations in which a large number of enterprises target similar

market segments with comparable strategies in which the market grows slowly

price is the most important differentiation factor and high exit barriers exist a

negative impact on the industryrsquos profitability is effected48

The threat of new entrants can be determined by the entry barriers of a market The

competitive pressure on existing enterprises increases with low entry barriers In

such a situation important elements of the market (eg shares of the market price

level) can change due to the entry of new market participants49

The bargaining power of buyers determines to what extent customers can influence

enterprises by the amount of consumption and the pressure on margins Important

indexes of a high degree of buyer power include high fixed costs in the industry

existence of supplements of the product or service high degree of customer

concentration customers` knowledge of production costs possibility of a reverse

integration of customers high growth rates of the market and a strong

individualization of customer demand50

The bargaining power of suppliers affects industry profitability if for example a

concentrated supplier group dominates over existing enterprises in the market

which are not important buyers for the suppliers Then the industry faces high

margin pressure by the suppliers

A threat of substitute products and services exists in particular if cheaper or higher-

quality products and services are able to reduce existing sales volumes of a market

or an enterprise51 The future sales potential of existing enterprises becomes limited

and industry competition increases

48 Porter (1985) 49 Porter (1979) Recklies (2001) 50 Recklies (2001) 51 Recklies (2001)

14

Critics of this model state that it neglects the impact of complements as a sixth

force of the industry since they may facilitate or hinder the commercialization of

certain goods However Porter argues that complements are not a force itself but

they affect profitability in the way that they influence the five forces and that `the

strategist must trace the positive or negative influence of complements on all five

forces to ascertain their impact on profitability`52

One limitation of this model is based on studies which indicate that company-

specific factors may have a more important impact on profit than industry forces53

Furthermore the model suggests relatively static and stable market structure which

makes it difficult to assess contemporary dynamic markets54

The model does not assess the impact of the parent company on its subsidiary

which is especially important in the banking sector in which parent companies

often have a strong impact on the performance of their subsidiary or branch The

parenting advantage includes the stand-alone influence through monitoring and

influence on management decisions or capital expenses Furthermore parents

create value by enhancing synergies within the group offering corporate functions

or managing portfolios55

42 Rivalry among existing competitors

In this section the intensity of competitive rivalry among existing competitors in

the German retail banking sector is discussed In this regard an analysis of industry

structure industry growth and exit barriers will be conducted

Industry structure The German banking market is characterized by a three-pillar

system which is reflected by the strict distinction between public-law banks

cooperative banks and private banks56 Each pursues different goals and is subject

to different regulations Private commercial banks pursue the goal of profit

maximization whereas saving banks serve the public contract of offering secure

52 Porter (1997)p11 53 Zack (1999) 54 Recklies (2001) 55 Goold Cambpell and Alexander (1994) 56 Gramlich (2005)

saving possibilities and loans C

interest of their members

banking market is structured as follow

Figure 3(own illustration based on Sch

Public-law banks including saving banks and state banks

total balance sheet volume of banks in Germany

do not participate in retail banking The cooperative bank sector amounts to 11

the total including cooperative banks

cooperative central banks

commercial banks including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

31 of total balance sheet volume

European Research (ZWE) 43 of experts state that the three

important or very important and

for the low number of cross

In order to describe industry rivalry among maj

retail sector the following table illustrates the number of customers per bank in

Germany

57 Engerer (2006) 58 Koumlhler (2008b)

banks 24

Private commercial banks 31

15

possibilities and loans Cooperative banks primarily serve the economic

interest of their members57 In terms of total balance sheet volume the German

banking market is structured as follows

Figure 3 Structure of the German Banking Sector(own illustration based on Schrooten 2009)

law banks including saving banks and state banks amount to 33 of the

total balance sheet volume of banks in Germany However state banks

do not participate in retail banking The cooperative bank sector amounts to 11

including cooperative banks which participate in retail ban

cooperative central banks which primarily serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

alance sheet volume According to a recent survey of the Center for

European Research (ZWE) 43 of experts state that the three-pillar system is

important or very important and 33 state that it is the critical factor responsible

cross-border mergers and acquisitions in Germany

In order to describe industry rivalry among major banks that participate in the

the following table illustrates the number of customers per bank in

Savings banks 13

State banks 20

Cooperative central banks

3Credit cooperative banks 8

Other banks 24

serve the economic

sheet volume the German

Structure of the German Banking Sector

amount to 33 of the

However state banks generally

do not participate in retail banking The cooperative bank sector amounts to 11 of

participate in retail banking and

serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks amount to

According to a recent survey of the Center for

pillar system is

33 state that it is the critical factor responsible

border mergers and acquisitions in Germany58

or banks that participate in the

the following table illustrates the number of customers per bank in

State banks 20

Cooperative central banks

16

Figure 4 Customers of German Banks at the end of 2007 in millions (own illustration based on Deutsche Bank 2008)

With approximately 50 million customers savings banks are the market leader in

the German retail banking sector Although state liability assumption for savings

banks was abolished in 2005 because the EU saw in it an unacceptable subsidy to

the disadvantage of private banks customers still associate the name `Sparkasse`

with state guarantees The specific characteristic of a saving bank is based on its

public contract in that it has to accept customers with poor credit-worthiness that

profits should be used to enhance public wealth and that the middle class should be

supplied with loans59

With approximately 30 million customers cooperative banks are the second major

player in the German retail banking sector Nearly half of these customers are

members of the cooperative banks60 In contrast to the profit maximization goal of

private commercial banks their aim is to fund their members and secure their

economic independence Although cooperative banks are economically and legally

independent in the different regions they appear uniformly as a group under the

brand of ldquoVolks- und Raiffeisenbankenrdquo With regard to growth in customer base

cooperative banks benefit from the advantage of having the regional flexibility that

59 Kruck (2008) 60 Online Raiffeisen Bank Homepage

31

4

61

118

242

30

50

0 10 20 30 40 50 60

Citibank

Hypovereinsbank

ING DiBa

Commerzbank and Dresdner Bank

Postbank and Deutsche Bank

Credit Unions (Volksbanken)

Savings Banks (Sparkassen)

17

allows for topical advertisement as well as a centralized management focus on

improving reputation61

The third group comprises the major private commercial banks including Deutsche

Bank Postbank Commerzbank and Hypovereinsbank Deutsche Bank is a leading

multinational investment bank but with relatively low market share in the retail

banking market Deutsche Bank (97 million clients) is acquiring Postbank (145

million clients) with its broad branch network in a three-step process Together

they have 242 million clients However Heino Ruland from the analyst company

Frankfurt Finanz Partner argues that Deutsche Bank might not be able to capitalize

on the financially weaker Postbank clients as Deutsche Bank is specialized in

corporate clients62 With regard to rivalry intensity and market profitability Rainer

Neske supervisory board member and head of private amp business clients of

Deutsche Bank emphasizes that the German retail banking market is too

fragmented to be highly profitable and that Deutsche Bank does not seek to

compete on the price level but defines itself through performance quality and

consultancy63

Commerzbank is the second largest private commercial bank in Germany After the

acquisition of Dresdner Bank in 2009 Commerzbank now serves more than 12

million clients (of these 11 million private and one million corporate clients) and

pursues the goal of becoming the market leader in Germany64

UniCredit Bank AG with the brand name Hypovereinsbank (HVB) is a subsidiary

of UniCredirSpA and is the third largest private commercial bank in Germany

HVB serves approximately four million clients predominantly in north Germany

and in Bavaria As its retail banking segment could only report marginal profits in

2009 speculation about a sale or acquisition in this segment has come up As the

Swedish SEB (Skandinaviska Enskilda Bank) is considering selling its German

retail segment with 174 branches and one million clients experts now regard HVB

as a major buying candidate65

61 Schwarzbauer (2009) 62 Kreiler (2008) 63 Deutsche Bank (2009) 64 Kreiler (2008) 65 Houmlpner and Nagl (2010)

18

ING DiBa AG is a subsidiary of the Dutch ING Group and serves over 6 million

clients In contrast to savings cooperative and the major private commercial

banks ING DiBa is specialized in direct banking which distributes services via

telephone the internet or post instead of through branches In Germany ING

DiBa is the leader in direct banking but there are many other direct banks such

as Comdirect (a subsidiary of Commerzbank) Volkswagen Bank or DAB Bank

(a subsidiary of HVB) Competition takes place not only among direct banks but

also between direct and branch banks For instance many saving banks have

blocked the opportunity for customers of direct banks to withdraw cash from their

automated teller machines As savings banks can only charge Euro 174 for

withdrawals via visa cards they fear that direct banks can gain market share by

offering attractive account options with a convenient wide-area ATM provision66

Targobank (former Citibank Deutschland) was acquired by the French

cooperative bank Creacutedit Mutel and now serves more than 34 million clients in

Germany in 2010 The bank is specialized in private retail customers with

branches and direct banking67

In conclusion the degree of concentration in the German retail banking market is

very low which reduces the overall profitability of this sector for two main

reasons Banks earn higher profits in concentrated markets as they obtain either

monopoly rents (structure-conduct-performance paradigm) or due to high market

shares that are gained by more efficient and profitable banks (efficient structure

hypothesis)68 As retail banking services are largely standardized product

differentiation is low and price differentiation is often the only option As public-

law banks serve other interests than profit maximization existing private banks

and MNBs that want to enter this market have a competitive disadvantage The

low switching costs of clients intensifies competition on the price level and thus

reduces the profitability of the market However brand identification and

customer relationships are also important which decreases the willingness of

clients to switch solely on the basis of price comparison In summary market

structure indicates a very high degree of rivalry among existing competitors

66 Online Financial Times Deutschland (2010) 67 Targobank (2010) 68 Havrylchyk and Jurzyk (2006) p15

19

Industry growth In this section industry growth will be examined in a dynamic

analysis of three relevant market growth indicators the future long-run

development of the German population the historical development of the number

of banks and branches in Germany and the historical development of market-

share allocation in the context of major retail banking activities

In the long-run market growth depends on the future numerical development of

the market`s customers - the German population As the growth of population

through birth and immigration is smaller than its decrease by virtue of the mortality

rate and emigration the Federal Statistical Office in Germany estimates a sharp

decline of the German population

Figure 5 Estimated Development of German Population (in millions)

(Federal Statistical Office 2009)

The Federal Statistical Office predicts that the trend of decline in population since

2003 will continue and intensify Whereas approximately 82 million people lived

in Germany in 2008 only between 65 million (average lower limit of the

population with 100000 immigrants yearly) and 70 million people (average

upper limit of the population with 200000 immigrants yearly) will reside in

Germany in 2060 Furthermore the decreasing number of births and the ageing of

the current strongly represented middle age group will lead to substantial changes

in the age structure of the population From 2008 to 2060 the proportion of people

from 65 to 80 years will increase 15 to 20 and the proportion of people over

80 years of age will increase from 5 to 14 of the population69 The

69 Federal Statistical Office (2009)

Average lower limit

Average upper limit

20

implications of the aging population for banks will be discussed in the comparison

between direct banks and BampM banks in section 66 of this thesis

The second indicator of industry growth deals with the number of banks and bank

branches in the German market The overall number of banks in Germany

decreased from 3785 in 1995 to 2300 in 2006 As retail banking usually depends

on the number branches maintained their development in Germany will be

examined

Figure 6 Development of Total Bank Branches in Germany (own illustration based on Koumlhler2008a)

Savings banks and cooperative banks have reduced the number of branches

significantly Public-sector banks (savings banks state banks etc) with 18757

branches and cooperative banks with 16028 branches in 1998 reduced the

number of branches to 14252 and 12303 respectively in 2006 Moreover the

number of branches of major commercial banks decreased from 19055 in 1998 to

8879 in 2006

The main cause for the decrease of branches is the high fixed costs which can not

be recouped from low-revenue standard products that can also be distributed

through alternative low-cost channels such as the internet70

70 Koumlhler and Land (2008)

67930 6666363186

59929 58546 5693653931

5086847244 45467 44100

40332

0

10000

20000

30000

40000

50000

60000

70000

80000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

21

As a third indicator of industry growth this paper reflects on the allocation of

market share within the retail banking sector in order to indentify trends that may

affect overall market growth This paper will reflect on market share in two major

retail banking segments - savings deposits and loans The German Central Bank

classifies the banking market in terms of savings banks cooperative banks direct

banks and credit banks The latter include universal banks which are private

commercial banks branches of foreign banks regional banks and other private

banks

This section reflects the development of market share regarding short- medium-

and long-term saving accounts and examines the allocation of loans to corporate

clients consumers (consumer loans) private households and self-employed

persons

In the period from 1998 to 2006 the market for medium-term saving deposits with

a cancellation period under three months has been dominated by saving banks (53

market share in 2006) and cooperative banks (29 market share in 2006) In the

same period the market share for long-term saving deposits with a cancellation

period above three months has also continuously been dominated by savings banks

(65 market share in 2006) and cooperative banks (24 market share in 2006)

However with regard to deposits that mature daily direct banks were able to

increase market share from approximately 15 in 1998 to over 15 in 2006

Figure 7 Market share development of saving accounts that mature daily (own illustration based on Deutsche Bundesbank 2007)

000

500

1000

1500

2000

2500

3000

3500

4000

4500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Banks

Cooperative Banks

Savings Banks

Credit Banks

22

From 1998 to 2006 market share for loans for corporate clients has been

continuously dominated by credit banks (53 market share in 2006) and savings

banks (34 market share in 2006) However this data also comprises loans for

medium and large corporations which are not part of the retail banking market

Loans for private households and self-employed persons have predominately been

granted by savings banks (39 market share in 2006) credit banks (30 market

share in 2006) and cooperative banks (25 market share in 2006) though direct

banks were able to gain some market share from 0 in 1998 up to 5 in 2006

Even more significantly direct banks were able to gain over 16 market share in

the segment of consumer loans

Figure 8 Market share development of consumer loans (own illustration based on Deutsche Bundesbank 2007)

Hence the most significant growth indicator of the retail banking market results

from the emergence of direct banks which were able to gain substantial market

share in consumper loans and deposits that mature daily

In conclusion the industry growth analysis indentifies the following growth

indicators Firstly a sharp decrease in the German population in the following

decades will reduce growth and increase industry rivalry Moreover the

demographic change increases the proportion of old people in the population

Secondly the number of branches in Germany is decreasing due to high fixed

costs of branches In order to be profitable in retail banking the existing branches

must serve a large quantity of customers which leads to strong competition

relative to market share Thirdly the development of market share allocation

000

1000

2000

3000

4000

5000

6000

7000

2002 2003 2004 2005 2006

Savings Banks

Cooperative Banks

Direct Banks

Credit Banks

23

indicates that only direct banks have experienced significant growth from 1995 to

2006

Exit barriers From a perspective of Transaction Costs Economics one can argue

that exit barriers in branch banking are high for market participants as branches

and staff are highly specific assets that lose value when used in another situation

To a large extent these assets are locked into the context of retail banking

Moreover public-law banks usually have to serve the population regardless of

whether they are profitable or not In a situation in which a bank continuously

experiences losses staff and branches may be considered as sunk costs and thus

economically `irrationalacute exit barriers However theories suggest that staff and

branches are practically valid exit barriers and cause MNCs to stay in a market71

The high degree of exit barriers intensifies the strong rivalry among existing

competitors

43 Threat of New Entrants

New entrants usually seek to gain market share while applying pressure on prices

and costs and thus increasing the investments necessary to compete An expert

survey conducted by the ZEW emphasizes the importance of entry threat to the

German retail-banking market 6666 of market experts state that new

competitors (eg foreign banks) have an important or a very important impact on

industry rivalry72

In this section the threat of new entrants to existing market participants in the

German retail banking sector is discussed In this regard this section evaluates

legal entry barriers capital requirements the necessity of large scale operations

customer switching costs and incumbency advantages of existing domestic banks

Legal entry barriers are determined by governmental regulations in the German

Banking Act (GBA) and are supervised by the Federal Supervisory Authority73

According to section 32 para 1 (1) GBA companies that intend to pursue

commercial banking transactions or financial services in Germany require written

71 Hill Hwang and Kim (1990) 72 Koumlhler and Lang (2008) 73 Bundesanstalt fuumlr Finanzdienstleistungsaufsicht (2005)

24

permission from the Federal Financial Supervisory Authority ( ldquoBundesanstalt fuumlr

Finanzdienstleistungaufsichtrdquo) The execution of banking transactions or financial

services also exists when the operator has its headquarters or primary residence

abroad but repeatedly targets companies or individuals who have their primary

residence in Germany In order to obtain the permit several requirements are

examined (eg business plan qualified management etc)

Companies from third countries which intend to conduct banking transactions and

provide financial services in Germany must establish a subsidiary (section 32 para

1 in connection with ection 33 para 1 (6) GBA) or a branch (section 32 para 1 in

connection with section 53 GBA) in Germany Companies from third countries can

apply for an exemption according to section 2 para 4 GBA if the company is

supervised utilizing international accounting standards in the home country and the

responsible authority works together with the BaFin According to section 53b

GBA companies of EEA states are allowed to establish branches (section 53b para

2) but are also free to conduct cross-border financial services without a domestic

presence (section 53b para 2a) Section 32 para 1 GBA does not apply to business

that is motivated by the initiative of the domestic individual or enterprise (so called

passive service freedom)

Representations are limited to their representative function and are not allowed to

conduct or initiate any banking business

Capital requirements are low for cross-border lending and and relatively low for

representations With high equity modes such as branches and even more so with

subsidiaries capital requirements are relatively high as capital is required for

building a broad network of facilities and offering credit to customers Capital

requirements for direct banks are relatively low compared with those of BampM

banks

The necessity of large scale operation is related to the competitive advantage of

economies of scale A company that serves the market in the context of larger

quantities benefits from lower cost per unit In retail banking profit is gained by

having a large number of clients It is expensive to build up these numbers and to

establish a distribution network to serve them This necessity relates directly to the

strategy of the bank An acquisition offers a shortcut to these facilities although the

25

costs of integration can be high as well74 A MNB may also decide to target only a

certain geographical area with certain clients and therefore do not have to enter on

a very large scale

Customer switching costs are different for each individual In general customers

can easily change their banks and open a deposit account or apply for a loan at

another bank However they have to compare the different terms for usually small

transactions to evaluate the convenience of having a bank nearby and then to

decide to terminate the relationships with their current bank75

Finally the incumbency advantages of existing banks are important entry barriers

In particular they include established brand reputation possession of the most

favorable geographical locations and market knowledge Moreover established

banks may already have exclusive contracts with SMEs76

To conclude legal entry barriers are low and particularly low for banks from the

EEA Capital requirements for entering the market are high yet as far as equity

entry modes are concerned direct banks require relatively low capital as they

distribute their services through low-cost channels Banks need to attract many

customers to be profitable but banks strategy dictates whether or not to entrance

should occur on a large scale Moreover the incumbency advantages of existing

banks constitute important entry barriers

44 Threat of Substitute Products or Services

A substitute in retail banking is a service that offers an attractive trade-off to a bank

service or product As individuals and small firms do not regularly report financial

information as do large enterprises they rely primarily on bank lending However

there are additional forms of financing in the private equity or dept market77

Many non- and near- banks provide substitute products and services Near-banks or

quasi-banks are suppliers of financial services but are not classified as credit

institutes according to section 1 GBA Near-banks such as insurance companies or

credit card organizations however do provide substitute products or services Non-

74 Hughes and MacDonald (2009) 75 Adams (2002) 76 Adams (2002) 77 Xiaoqin and Terada-Hagiwara (2003)

26

banks such as department store chains catalog companies or car producers also

provide substitute services78 For instance instead of taking out a loan in order to

pay for a product individuals or small enterprises may decide to take on a leasing

contract for a certain asset or small enterprises can obtain a trade credit as well

Individuals may decide on buying products from insurance companies instead of

putting money into a bank account

Another substitute for both direct and BampM banks is the person-to-person (p2p)

lending business a new form of borrowing and lending money that takes place in a

web-based market place In this online platform borrowers are connected to

lenders through an auction-like process in which a lender who bids to provide a

loan for the lowest interest rate will be awarded the loan contract with the

borrower A p2p company mediates between private or company borrowers and

lenders and also executes transactions between the parties similar to the role which

e-bay plays in the trade of commercial goods79 The p2p lending business does not

involve traditional banks and thus can offer superior interest rates to borrowers and

higher returns for lenders

45 Bargaining Power of Suppliers

When a supplier group is more concentrated than the industry does not primarily

depend on the industry and when the industry faces high switching costs the

supplier group has strong bargaining power and can reduce the profit potential of

an industry In the retail banking market the most relevant suppliers include human

resources suppliers of capital resources and suppliers of information and

communication technology (ICT)80 Highly talented or experienced specialists are

strongly canvassed and have strong bargaining power with respect to their salary

and working conditions However in the aftermath of the financial crisis many

banks are planning a reduction of staff According to a study of Ernst amp Young

every fifth bank intends to decrease staff and only every 10th bank is planning an

increase81 Given the current situation of the employment market the bargaining

power of employees is relatively low Suppliers of highly specialized banking ICT

78 Gabler Wirtschaftslexikon (2010) 79 Deloitte (2009) p 12 80 Buumlschgen and Boumlrner (2003) 81 Ernst amp Young (2009)

27

solutions have strong bargaining power as switching costs for these systems are

very high Moreover the higher yield requirements of shareholders can be

interpreted as supplier power

46 Bargaining Power of Buyers

In retail banking there are many buyers with relatively low transaction volumes

which weakens their bargaining power However retail banking services are

standardized and buyers can easily find similar services Switching costs have

usually been relatively high for these low volume transactions but in the age of the

internet the market is very transparent and buyers can screen different offerings

more easily This does not necessarily imply that the cheapest banking service will

be chosen automatically as customers also seek a trustworthy brand especially in

times of financial crisis Moreover there are other factors that affect the switching

cost of the individual such as the location of the branch Yet there is a tendency

towards the increasing bargaining power of buyers

This is also substantiated by the ZEW survey 7984 of market experts state that

decreasing customer loyalty and increasing price sensibility are important or very

important factors with respect to the intensity of competition in the German retail

banking sector A comparison of former and modern retail customers also indicates

that the bargaining power of retail banking service users has increased

Former Retail Customer Modern Retail Customer

Passive information seeking

behavior

Active information seeking behavior

Hardy or little informed Good to very good know-how

High customer loyality Increasing willingness to switch

Fixation on the branch Expects multi-channel banking at all times

and places

Little market transparency High price transparency

Relatively undemanding Demanding

Figure 9 Comparison of former and modern retail customers (own illustration based on Swoboda 2004)

28

5 Foreign Bank Entry Strategies in Germany

This section illustrates mode choices for foreign bank entry in Germany Based on

the hierarchical model of market entry modes82 the foreign bank has the choice of

equity and non ndash equity modes of entry An advantage of the hierarchical model is

that it allows comparing between entry modes on different levels The main

difference between equity and non ndash equity modes is the degree of resource

commitment in the foreign country As classified at the beginning of this thesis

non-equity entry refers to international banking and equity entry refers to

multinational banking

The research question of this thesis considers multinational bank entry modes

International banking however is often a first step towards multinational banking

Hence this thesis will also discuss cross-border lending and alliances as non ndash

equity entry modes The following figure illustrates a comprehensive view of

market entry modes for banks

Figure 10 A hierarchical model of entry mode choices for banks (own illustration based on Pan and Tse 2000)

82 Pan and Tse (2000)

Entry Mode Choices

Non - Equity Modes

Export

Cross Border Lending

Contractual Agreements

Alliances

Equity Modes

Equity Joint Ventures

Greenfield Investment

Branch

Subsidiary

Representation

Acquisition

Subsidiary

Branch

29

The hierarchical model illustrates the various entry mode choices for entering the

German retail banking market The creation of a common European financial

market in which banks can integrate freely is a major goal of the European Union83

The previous section of this paper indicates that entry barriers are relatively low

and that the German market is highly competitive Hence the choice of a proper

entry mode which is appropriate to the capabilities and the strategy of the bank is

even more significant Therefore the following section will reflect on the strategic

concept governing the choice of entry modes as well as the proliferation of these

entry modes in the German retail banking market

An international bank that is not interested in investing equity in the foreign

market can enter by means of cross-border lending or by forming a non-equity

alliance These non-equity entry modes can help the bank to access niche markets

or to exploit locational advantages when the bank is located near the German

border

However a retail bank defined in the beginning of this paper as a bank that

`caters for ordinary individuals and small businessacute and that seeks to enter the

German market in order to gain significant revenue from deposits and loan

business might have to consider a physical presence in the foreign country

The analysis considers entry modes that are perceived as international banking

cross-border lending and non-equity strategic alliances Furthermore the equity

modes JVs and representations will be discussed

Subsequently this section compares the market entry of a branch through

Greenfield investment with the market entry of a subsidiary by virtue of

acquisition as these modes of entry are the most common in the German retail

banking market

Finally the following question will be addressed to what extent do demographic

and technical trends favor a direct bank entry mode over a brick and mortar bank

approach in Germany

83 Fidrmuc and Hainz (2008)

30

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks (own illustration)

51 Non ndash equity modes Export ndash Cross-Border Lending

Cross-border lending is equivalent to the export entry mode and is a simple non-

equity strategy to enter a foreign market A bank which participates in cross-

border lending must assess the creditworthiness of the individual borrower as well

as the country risk which involves the possibility that these loans will be impaired

by economic or political proceedings in the foreign country84 The country risk in

Germany is rather low as it is perceived to have a solid political and economic

situation (Country Rating A2) with a stable and a very efficient business

environment (Country Rating A1)85 As a bank will only have limited access to soft

information about the creditworthiness of the borrower the availability of loans

usually decreases and the interest on loans usually increases with distance86 Soft

information for private loans includes the previous experience with the account

management of the credit user environmental facts and a judgment relative to his

employment contract87 For corporate loans soft facts may include the market

environment corporate structure management a business plan as well as

84 Hughes and McDonald (2003) 85 Online wwwtrade-safelycom (2009) 86 Agrawal and Hauswald (2007) 87 Dizil (2009)

Entry Mode Choices of MNBs

Greenfield Investment

Branch

Brick and Mortar Bank Direct Bank

Acquisition

Subsidiary

Brick and Mortar Bank Direct Bank

5

2 Classification of Banks

21 Bank

This paper refers to banks as defined in the German Banking Act Section 1 GBA

defines financial institutes as enterprises which pursue banking transactions

insofar as the extent of these transactions requires commercial business operations

At least one of the following transactions has to be carried out security

transactions credit transactions payments transactions or other banking business

The enterprise which pursues banking transactions in Germany requires the

permission of the BaFin (Federal Institution for Finance Service Supervision)

according to section 32 GBA

22 Direct Bank

Direct banks are credit institutes which operate without a branch network and

utilize the internet and the telephone as direct communication channels through

which banking transactions are realized and marketing and customer service takes

place Thus direct banks establish cost advantages which they usually transmit in

the form of attractive terms15

23 Brick and Mortar Bank

A brick and mortar (BampM) company is a traditional street-side business that

deals with its customers face to face in an office that the company owns or rents16

A brick and mortar bank serves consumers in a physical facility as distinct from

providing online or telephone services only The term brick and mortar is not a

generally valid classification of a bank but in the jargon of e-commerce it is

frequently employed to distinguish from internet based enterprises In this thesis

the term brick and mortar bank is employed to differentiate between a direct bank

that operates through direct channels and one which operates solely through its

branch network The term brick and mortar is also distinguished from the term

click and mortar which is an expression for a form of multi-channel retailing in

15 Deutsche Bundesbank (2010) 16 Investopedia Dictionary (2010)

6

which both electronic distribution channels (click) and physical premises (mortar)

are utilized17

24 Multinational Bank

Multinational banks are defined as banks that have a physical presence in more

than one country In contrast international banks engage in cross-border operations

but do not establish a physical presence in foreign countries18

25 Retail Bank

There is no generally valid classification of retail banking in theoretical literature

or in practice19 A distinction in retail banking is often made with regard to its

target clientele In this regard some authors define retail banking as the offering of

banking and financial services to individuals and small and medium sized

enterprises20 Other sources define retail banking as the provision of these services

solely to individuals21 This paper employs the following classification of retail

banks `A retail bank is a bank that caters for ordinary individuals and small

business as distinct from large corporations Retail banking operations offer

deposit facilities lend money transfer funds and are prepared to deal in relatively

small amounts`22 In contrast to private and corporate banking retail banking

considers private clients with low to average income as well as small corporate

clients

2

Figure 1 Classification of retail banking clients

(own illustration based on Swoboda 2004)

17 Gabler Wirtschaftslexikon (2010) 18 Hersh and Weller (2002) 19 Muumlller and Joumlhnk (2005) 20 Pond (2007) FinanceWiki (2008) Tremblay and Tremblay (2007) 21 Frei Harker and Hunter (1998) Online Businessdictionarycom (2010) Investoglossarycom (2010) 22 Essvale Corporation Limited (2007)

Retail Banking

Medium and large corporate clients

Wealthy private clients

Small Corporate clients

Private clients

7

3 Market Entry Theories and Strategies

31 Transaction Costs Theory

In the transaction cost theory developed by Ronald Coase and Oliver E

Williamson a comparison of transaction costs determines the optimal form of

organization In TC Theory the entry mode decision is a tradeoff between the

control and the costs of resource commitment Entry modes vary in three major

aspects the cost of resource commitment control as the level of ownership and

environmental risks that may affect the committed resources Hence high-control

modes increase both risk and the potential return23

Williamson differentiates between ex-ante and ex-post transaction costs

Information and searching costs are incurred ex-ante in the process of collecting

market information and identifying suitable partners Negotiation and contract

costs arise ex-ante due to negotiations legal advisory and the determination of

contractual terms Monitoring costs develop ex-post for activities which serve to

control contractual obligations Conflict and enforcement costs arise ex-post due to

the different interpretation of the contract and the costs of enforcing contractual

regulations with sanctions negotiations or through court proceedings Adaption

costs are incurred due to ex-post changes in contractual agreements that become

necessary because of unpredictable developments24

TCE assumes the existence of bounded rationality and opportunism Bounded

rationality describes the limitation in human processing of information and the

planning of possible outcomes Opportunism describes the notion that humans may

act in a self-interested manner by manipulating information and being dishonest

The consequences of these assumptions are incomplete contracts and moral

hazards25 Vice versa opportunism occurs because firms can not write complete

contracts

The size of the transaction costs is determined in each case by the characteristics of

asset specificity uncertainty and frequency Asset specificity arises when the actor

in the market undertakes specific investments in order to fulfill his contractual 23 Chen and Mujtaba (2007) p322 24 Kieser and Ebers (2006) p278 25 Magill and Quenzii (1996) p11

8

obligations It refers to the degree to which long-lasting human or physical assets

are bound in a specific relationship and thus to the extent to which they provide

value in the context of a different situation26 In TCE markets can hardly solve the

problems that high uncertainty creates in combination with bounded rationality and

threats of opportunism Uncertainty includes environmental and behavioral

uncertainty Environmental uncertainty refers to political legal cultural and

economic uncertainties that may affect the success of business transactions

Behavioral uncertainty states that bounded rationality and the threat of opportunism

result in the high costs of monitoring a partner company27 If the similar

transactions are repeated frequently learning effects and economies of scale occur

and will reduce the transaction costs

32 Eclectic Theory

The eclectic theory28 (or OLI paradigm) was developed by John Dunning and is a

framework that merges different economic theories which explain foreign market

entry patterns of multinational corporations29 It states that the internationalization

of MNCs is determined by three sets of independent variables ownership

advantages (or firm- specific advantages) location advantages (or country specific

advantages) and internationalization advantages

The ownership advantage considers the competitive advantages of MNCs arising

from firm-specific characteristics such as size monopoly power economies of

scale management brand name technology and other resource capabilities30

These advantages are usually intangible assets and can be transferred at low costs31

The greater the competitive advantage of the MNC is the more likely it is able to

start or to increase its foreign production32

The location advantages arise from country specific benefits that can be divided

into three categories Firstly a host country may have economic advantages

comprising qualitative and quantitative factors such as production transports costs

26 Dietrich (1994) p18 27 Brouthers and Brouthers (2003) p1183 - 1185 28 Dunning (1980) Dunning (1988) Hill Kwang and Kim (1990) 29 Dunning (2002) 30 Forsbaeck and Oxelheim (2004) 31 Griffin and Pustay (2006) 32 Dunning (2002)

9

communication costs market size or tax incentives Secondly a host country may

offer political advantages in particular governmental policies that may influence

market entry Thirdly a host country may provide social and cultural advantages

including the psychic distance between the foreign and the domestic country as

well as language or cultural aspects that may have an impact on the market entry

decision The higher the attractions of the specific location the more likely it is that

MNCs will exploit their ownership advantage by entering the foreign market33

Because of the existence of transactions costs the internationalization incentive

advantage states that it must be profitable for the MNC to exploit these advantages

itself rather than through local companies (eg licensing)34

In economic literature the OLI paradigm has also been applied to the banking

sector In this regard ownership advantage may include easy access to a vehicle

currency Locational advantages may include country-specific regulations and

entry barriers Internationalization advantages can be information advantages and

access to local deposit bases35

Many empirical studies on the banking market have utilized the eclectic paradigm

as a basic framework For example a study of bank entry into CEE markets

concludes that the ownership advantages of foreign MNBs are strong compared to

banks in emerging markets and especially when the foreign country experiences a

banking crisis36 An application of the OLI paradigm to the Spanish banking

market has shown that bank size and multinational experience of MNBs favor

stronger commitment in the foreign country whereas distance is an entry barrier37

However theoretical literature also states that in service industries clients close to

the MNBs headquarters may be served from this location whereas clients in distant

markets require a physical presence of the MNB in the foreign country which

favors a foreign market entry with increasing distance38

33 Dunning (2002) 34 Hagen (1997) 35 Yannopoulus (1983) 36 Uiboupin and Sorg (2006) 37 Blandoacuten (1998) 38 Blondoacuten (1998) Terpstra and Yu (1988)

10

33 Strategy of Defensive Expansion

A common approach employed to explain the expansion of MNBs involves the

theory of defensive expansion which is also referred to as the acutefollow-the-

customeracute argument

This theory states that MNBs expand abroad in order to provide services for

domestic clients which are often large enterprises that have entered a foreign

market39 The provision of financial services in the foreign country usually requires

a presence at important economic centres Hence to some degree expanding

corporations impose pressure on their domestic banks to follow-up40

The term acutedefensiveacute is derived from the idea that a failure to expand may lead to a

loss of the client not only in the foreign country but also in the domestic one as

the client may associate with a foreign MNB41 Consequently MNBs which pursue

this strategy seek to prevent losses rather then to generate new profits in the foreign

market42 Furthermore the domestic bank has an incomparable competitive

advantage over banks in the foreign country with regard to the knowledge of

customer needs the respective risk of credit default as well as an interest in cross-

selling products such as financial advisory43

Due to earlier business relationships with the client the domestic bank has reduced

costs for examining the financial capacities of the respective enterprise and thus

can offer cheaper services44 Most foreign entry evidence supports the defensive

expansion theory45

A study on this theory with respect to retail banking has revealed that MNBs

sometimes expand abroad in order to provide banking services to specific

communities46

39 Trend im retail-banking koumlhler 40 Henneberger and Graf (2000) 41 Mullineux and Murinde (2003) 42 Naaborg (2007) 43 Knoop (2006) 44 Bhattacharya (1994) 45 Bhattacharya (1994) Naaborg (2007) 46 Tschoegl (1987)

11

34 Strategy of Offensive Expansion

MNBs that offensively expand abroad primarily seek to increase their customer

base both in the home and in the foreign country Firstly the establishment of

foreign branches and subsidiaries enables the MNB to expand their services to

domestic residents who benefit from the international orientation of the bank

These may include customers that have business partners in the foreign country

Secondly MNBs may target new customers in the foreign country in particular

MNEs or foreign subsidiaries of domestic enterprises As the MNB must in both

cases entice customers away from other banks the MNB has to offer attractive and

competitive conditions for their financial services47

47 Buumlschgen (1998) p604

12

4 Industry Analysis German Retail Banking Sector

41 Porter`s Five Forces

In the school of Industrial Economics the five-forces model has established itself

as a core element of industry analysis Porter`s analysis framework is built on the

following five market forces that shape the strategy of competitors threat of new

entrants threat of substitute products or services bargaining power of buyers and

suppliers as well as rivalry among existing competitors

Porterrsquos concept is based on the knowledge that the strategy of an enterprise must

orient itself to its market environment whereby the competitive strategy arises

from a differentiated understanding of the market structure and the knowledge of

how it changes The effects of these forces determine the intensity of the

competition in a market and with it its profitability and attractiveness Therefore

the aim of the enterprise strategy should be reflected in the search for possibilities

for the reduction or use of these competitive forces relative to its own enterprise In

this regard Porter`s model is conducive to the analysis of the driving forces

working in the respective industry

Figure 2 Michael E Porter`s five forces model (Own illustration based on Porter 1979)

Industry Rivalry

Threat of New

Entrants

Bargaining Power of

Buyers

Threat of Substitute Products

and Services

Bargaining Power of Suppliers

13

Porter`s framework is a useful and frequently utilized analytical tool to describe the

foundations of industry competition

A high degree of rivalry among the existing enterprises leads to high competitive

pressure and can lower profit margins and the profitability of individual

enterprises In situations in which a large number of enterprises target similar

market segments with comparable strategies in which the market grows slowly

price is the most important differentiation factor and high exit barriers exist a

negative impact on the industryrsquos profitability is effected48

The threat of new entrants can be determined by the entry barriers of a market The

competitive pressure on existing enterprises increases with low entry barriers In

such a situation important elements of the market (eg shares of the market price

level) can change due to the entry of new market participants49

The bargaining power of buyers determines to what extent customers can influence

enterprises by the amount of consumption and the pressure on margins Important

indexes of a high degree of buyer power include high fixed costs in the industry

existence of supplements of the product or service high degree of customer

concentration customers` knowledge of production costs possibility of a reverse

integration of customers high growth rates of the market and a strong

individualization of customer demand50

The bargaining power of suppliers affects industry profitability if for example a

concentrated supplier group dominates over existing enterprises in the market

which are not important buyers for the suppliers Then the industry faces high

margin pressure by the suppliers

A threat of substitute products and services exists in particular if cheaper or higher-

quality products and services are able to reduce existing sales volumes of a market

or an enterprise51 The future sales potential of existing enterprises becomes limited

and industry competition increases

48 Porter (1985) 49 Porter (1979) Recklies (2001) 50 Recklies (2001) 51 Recklies (2001)

14

Critics of this model state that it neglects the impact of complements as a sixth

force of the industry since they may facilitate or hinder the commercialization of

certain goods However Porter argues that complements are not a force itself but

they affect profitability in the way that they influence the five forces and that `the

strategist must trace the positive or negative influence of complements on all five

forces to ascertain their impact on profitability`52

One limitation of this model is based on studies which indicate that company-

specific factors may have a more important impact on profit than industry forces53

Furthermore the model suggests relatively static and stable market structure which

makes it difficult to assess contemporary dynamic markets54

The model does not assess the impact of the parent company on its subsidiary

which is especially important in the banking sector in which parent companies

often have a strong impact on the performance of their subsidiary or branch The

parenting advantage includes the stand-alone influence through monitoring and

influence on management decisions or capital expenses Furthermore parents

create value by enhancing synergies within the group offering corporate functions

or managing portfolios55

42 Rivalry among existing competitors

In this section the intensity of competitive rivalry among existing competitors in

the German retail banking sector is discussed In this regard an analysis of industry

structure industry growth and exit barriers will be conducted

Industry structure The German banking market is characterized by a three-pillar

system which is reflected by the strict distinction between public-law banks

cooperative banks and private banks56 Each pursues different goals and is subject

to different regulations Private commercial banks pursue the goal of profit

maximization whereas saving banks serve the public contract of offering secure

52 Porter (1997)p11 53 Zack (1999) 54 Recklies (2001) 55 Goold Cambpell and Alexander (1994) 56 Gramlich (2005)

saving possibilities and loans C

interest of their members

banking market is structured as follow

Figure 3(own illustration based on Sch

Public-law banks including saving banks and state banks

total balance sheet volume of banks in Germany

do not participate in retail banking The cooperative bank sector amounts to 11

the total including cooperative banks

cooperative central banks

commercial banks including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

31 of total balance sheet volume

European Research (ZWE) 43 of experts state that the three

important or very important and

for the low number of cross

In order to describe industry rivalry among maj

retail sector the following table illustrates the number of customers per bank in

Germany

57 Engerer (2006) 58 Koumlhler (2008b)

banks 24

Private commercial banks 31

15

possibilities and loans Cooperative banks primarily serve the economic

interest of their members57 In terms of total balance sheet volume the German

banking market is structured as follows

Figure 3 Structure of the German Banking Sector(own illustration based on Schrooten 2009)

law banks including saving banks and state banks amount to 33 of the

total balance sheet volume of banks in Germany However state banks

do not participate in retail banking The cooperative bank sector amounts to 11

including cooperative banks which participate in retail ban

cooperative central banks which primarily serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks

alance sheet volume According to a recent survey of the Center for

European Research (ZWE) 43 of experts state that the three-pillar system is

important or very important and 33 state that it is the critical factor responsible

cross-border mergers and acquisitions in Germany

In order to describe industry rivalry among major banks that participate in the

the following table illustrates the number of customers per bank in

Savings banks 13

State banks 20

Cooperative central banks

3Credit cooperative banks 8

Other banks 24

serve the economic

sheet volume the German

Structure of the German Banking Sector

amount to 33 of the

However state banks generally

do not participate in retail banking The cooperative bank sector amounts to 11 of

participate in retail banking and

serve large corporate clients Private

including large German Banks (Deutsche Bank Commerce

Bank Post Bank Hypovereins Bank) private banks and foreign banks amount to

According to a recent survey of the Center for

pillar system is

33 state that it is the critical factor responsible

border mergers and acquisitions in Germany58

or banks that participate in the

the following table illustrates the number of customers per bank in

State banks 20

Cooperative central banks

16

Figure 4 Customers of German Banks at the end of 2007 in millions (own illustration based on Deutsche Bank 2008)

With approximately 50 million customers savings banks are the market leader in

the German retail banking sector Although state liability assumption for savings

banks was abolished in 2005 because the EU saw in it an unacceptable subsidy to

the disadvantage of private banks customers still associate the name `Sparkasse`

with state guarantees The specific characteristic of a saving bank is based on its

public contract in that it has to accept customers with poor credit-worthiness that

profits should be used to enhance public wealth and that the middle class should be

supplied with loans59

With approximately 30 million customers cooperative banks are the second major

player in the German retail banking sector Nearly half of these customers are

members of the cooperative banks60 In contrast to the profit maximization goal of

private commercial banks their aim is to fund their members and secure their

economic independence Although cooperative banks are economically and legally

independent in the different regions they appear uniformly as a group under the

brand of ldquoVolks- und Raiffeisenbankenrdquo With regard to growth in customer base

cooperative banks benefit from the advantage of having the regional flexibility that

59 Kruck (2008) 60 Online Raiffeisen Bank Homepage

31

4

61

118

242

30

50

0 10 20 30 40 50 60

Citibank

Hypovereinsbank

ING DiBa

Commerzbank and Dresdner Bank

Postbank and Deutsche Bank

Credit Unions (Volksbanken)

Savings Banks (Sparkassen)

17

allows for topical advertisement as well as a centralized management focus on

improving reputation61

The third group comprises the major private commercial banks including Deutsche

Bank Postbank Commerzbank and Hypovereinsbank Deutsche Bank is a leading

multinational investment bank but with relatively low market share in the retail

banking market Deutsche Bank (97 million clients) is acquiring Postbank (145

million clients) with its broad branch network in a three-step process Together

they have 242 million clients However Heino Ruland from the analyst company

Frankfurt Finanz Partner argues that Deutsche Bank might not be able to capitalize

on the financially weaker Postbank clients as Deutsche Bank is specialized in

corporate clients62 With regard to rivalry intensity and market profitability Rainer

Neske supervisory board member and head of private amp business clients of

Deutsche Bank emphasizes that the German retail banking market is too

fragmented to be highly profitable and that Deutsche Bank does not seek to

compete on the price level but defines itself through performance quality and

consultancy63

Commerzbank is the second largest private commercial bank in Germany After the

acquisition of Dresdner Bank in 2009 Commerzbank now serves more than 12

million clients (of these 11 million private and one million corporate clients) and

pursues the goal of becoming the market leader in Germany64

UniCredit Bank AG with the brand name Hypovereinsbank (HVB) is a subsidiary

of UniCredirSpA and is the third largest private commercial bank in Germany

HVB serves approximately four million clients predominantly in north Germany

and in Bavaria As its retail banking segment could only report marginal profits in

2009 speculation about a sale or acquisition in this segment has come up As the

Swedish SEB (Skandinaviska Enskilda Bank) is considering selling its German

retail segment with 174 branches and one million clients experts now regard HVB

as a major buying candidate65

61 Schwarzbauer (2009) 62 Kreiler (2008) 63 Deutsche Bank (2009) 64 Kreiler (2008) 65 Houmlpner and Nagl (2010)

18

ING DiBa AG is a subsidiary of the Dutch ING Group and serves over 6 million

clients In contrast to savings cooperative and the major private commercial

banks ING DiBa is specialized in direct banking which distributes services via

telephone the internet or post instead of through branches In Germany ING

DiBa is the leader in direct banking but there are many other direct banks such

as Comdirect (a subsidiary of Commerzbank) Volkswagen Bank or DAB Bank

(a subsidiary of HVB) Competition takes place not only among direct banks but

also between direct and branch banks For instance many saving banks have

blocked the opportunity for customers of direct banks to withdraw cash from their

automated teller machines As savings banks can only charge Euro 174 for

withdrawals via visa cards they fear that direct banks can gain market share by

offering attractive account options with a convenient wide-area ATM provision66

Targobank (former Citibank Deutschland) was acquired by the French

cooperative bank Creacutedit Mutel and now serves more than 34 million clients in

Germany in 2010 The bank is specialized in private retail customers with

branches and direct banking67

In conclusion the degree of concentration in the German retail banking market is

very low which reduces the overall profitability of this sector for two main

reasons Banks earn higher profits in concentrated markets as they obtain either

monopoly rents (structure-conduct-performance paradigm) or due to high market

shares that are gained by more efficient and profitable banks (efficient structure

hypothesis)68 As retail banking services are largely standardized product

differentiation is low and price differentiation is often the only option As public-

law banks serve other interests than profit maximization existing private banks

and MNBs that want to enter this market have a competitive disadvantage The

low switching costs of clients intensifies competition on the price level and thus

reduces the profitability of the market However brand identification and

customer relationships are also important which decreases the willingness of

clients to switch solely on the basis of price comparison In summary market

structure indicates a very high degree of rivalry among existing competitors

66 Online Financial Times Deutschland (2010) 67 Targobank (2010) 68 Havrylchyk and Jurzyk (2006) p15

19

Industry growth In this section industry growth will be examined in a dynamic

analysis of three relevant market growth indicators the future long-run

development of the German population the historical development of the number

of banks and branches in Germany and the historical development of market-

share allocation in the context of major retail banking activities

In the long-run market growth depends on the future numerical development of

the market`s customers - the German population As the growth of population

through birth and immigration is smaller than its decrease by virtue of the mortality

rate and emigration the Federal Statistical Office in Germany estimates a sharp

decline of the German population

Figure 5 Estimated Development of German Population (in millions)

(Federal Statistical Office 2009)

The Federal Statistical Office predicts that the trend of decline in population since

2003 will continue and intensify Whereas approximately 82 million people lived

in Germany in 2008 only between 65 million (average lower limit of the

population with 100000 immigrants yearly) and 70 million people (average

upper limit of the population with 200000 immigrants yearly) will reside in

Germany in 2060 Furthermore the decreasing number of births and the ageing of

the current strongly represented middle age group will lead to substantial changes

in the age structure of the population From 2008 to 2060 the proportion of people

from 65 to 80 years will increase 15 to 20 and the proportion of people over

80 years of age will increase from 5 to 14 of the population69 The

69 Federal Statistical Office (2009)

Average lower limit

Average upper limit

20

implications of the aging population for banks will be discussed in the comparison

between direct banks and BampM banks in section 66 of this thesis

The second indicator of industry growth deals with the number of banks and bank

branches in the German market The overall number of banks in Germany

decreased from 3785 in 1995 to 2300 in 2006 As retail banking usually depends

on the number branches maintained their development in Germany will be

examined

Figure 6 Development of Total Bank Branches in Germany (own illustration based on Koumlhler2008a)

Savings banks and cooperative banks have reduced the number of branches

significantly Public-sector banks (savings banks state banks etc) with 18757

branches and cooperative banks with 16028 branches in 1998 reduced the

number of branches to 14252 and 12303 respectively in 2006 Moreover the

number of branches of major commercial banks decreased from 19055 in 1998 to

8879 in 2006

The main cause for the decrease of branches is the high fixed costs which can not

be recouped from low-revenue standard products that can also be distributed

through alternative low-cost channels such as the internet70

70 Koumlhler and Land (2008)

67930 6666363186

59929 58546 5693653931

5086847244 45467 44100

40332

0

10000

20000

30000

40000

50000

60000

70000

80000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

21

As a third indicator of industry growth this paper reflects on the allocation of

market share within the retail banking sector in order to indentify trends that may

affect overall market growth This paper will reflect on market share in two major

retail banking segments - savings deposits and loans The German Central Bank

classifies the banking market in terms of savings banks cooperative banks direct

banks and credit banks The latter include universal banks which are private

commercial banks branches of foreign banks regional banks and other private

banks

This section reflects the development of market share regarding short- medium-

and long-term saving accounts and examines the allocation of loans to corporate

clients consumers (consumer loans) private households and self-employed

persons

In the period from 1998 to 2006 the market for medium-term saving deposits with

a cancellation period under three months has been dominated by saving banks (53

market share in 2006) and cooperative banks (29 market share in 2006) In the

same period the market share for long-term saving deposits with a cancellation

period above three months has also continuously been dominated by savings banks

(65 market share in 2006) and cooperative banks (24 market share in 2006)

However with regard to deposits that mature daily direct banks were able to

increase market share from approximately 15 in 1998 to over 15 in 2006

Figure 7 Market share development of saving accounts that mature daily (own illustration based on Deutsche Bundesbank 2007)

000

500

1000

1500

2000

2500

3000

3500

4000

4500

1998 1999 2000 2001 2002 2003 2004 2005 2006

Direct Banks

Cooperative Banks

Savings Banks

Credit Banks

22

From 1998 to 2006 market share for loans for corporate clients has been

continuously dominated by credit banks (53 market share in 2006) and savings

banks (34 market share in 2006) However this data also comprises loans for

medium and large corporations which are not part of the retail banking market

Loans for private households and self-employed persons have predominately been

granted by savings banks (39 market share in 2006) credit banks (30 market

share in 2006) and cooperative banks (25 market share in 2006) though direct

banks were able to gain some market share from 0 in 1998 up to 5 in 2006

Even more significantly direct banks were able to gain over 16 market share in

the segment of consumer loans

Figure 8 Market share development of consumer loans (own illustration based on Deutsche Bundesbank 2007)

Hence the most significant growth indicator of the retail banking market results

from the emergence of direct banks which were able to gain substantial market

share in consumper loans and deposits that mature daily

In conclusion the industry growth analysis indentifies the following growth

indicators Firstly a sharp decrease in the German population in the following

decades will reduce growth and increase industry rivalry Moreover the

demographic change increases the proportion of old people in the population

Secondly the number of branches in Germany is decreasing due to high fixed

costs of branches In order to be profitable in retail banking the existing branches

must serve a large quantity of customers which leads to strong competition

relative to market share Thirdly the development of market share allocation

000

1000

2000

3000

4000

5000

6000

7000

2002 2003 2004 2005 2006

Savings Banks

Cooperative Banks

Direct Banks

Credit Banks

23

indicates that only direct banks have experienced significant growth from 1995 to

2006

Exit barriers From a perspective of Transaction Costs Economics one can argue

that exit barriers in branch banking are high for market participants as branches

and staff are highly specific assets that lose value when used in another situation

To a large extent these assets are locked into the context of retail banking

Moreover public-law banks usually have to serve the population regardless of

whether they are profitable or not In a situation in which a bank continuously

experiences losses staff and branches may be considered as sunk costs and thus

economically `irrationalacute exit barriers However theories suggest that staff and

branches are practically valid exit barriers and cause MNCs to stay in a market71

The high degree of exit barriers intensifies the strong rivalry among existing

competitors

43 Threat of New Entrants

New entrants usually seek to gain market share while applying pressure on prices

and costs and thus increasing the investments necessary to compete An expert

survey conducted by the ZEW emphasizes the importance of entry threat to the

German retail-banking market 6666 of market experts state that new

competitors (eg foreign banks) have an important or a very important impact on

industry rivalry72

In this section the threat of new entrants to existing market participants in the

German retail banking sector is discussed In this regard this section evaluates

legal entry barriers capital requirements the necessity of large scale operations

customer switching costs and incumbency advantages of existing domestic banks

Legal entry barriers are determined by governmental regulations in the German

Banking Act (GBA) and are supervised by the Federal Supervisory Authority73

According to section 32 para 1 (1) GBA companies that intend to pursue

commercial banking transactions or financial services in Germany require written

71 Hill Hwang and Kim (1990) 72 Koumlhler and Lang (2008) 73 Bundesanstalt fuumlr Finanzdienstleistungsaufsicht (2005)

24

permission from the Federal Financial Supervisory Authority ( ldquoBundesanstalt fuumlr

Finanzdienstleistungaufsichtrdquo) The execution of banking transactions or financial

services also exists when the operator has its headquarters or primary residence

abroad but repeatedly targets companies or individuals who have their primary

residence in Germany In order to obtain the permit several requirements are

examined (eg business plan qualified management etc)

Companies from third countries which intend to conduct banking transactions and

provide financial services in Germany must establish a subsidiary (section 32 para

1 in connection with ection 33 para 1 (6) GBA) or a branch (section 32 para 1 in

connection with section 53 GBA) in Germany Companies from third countries can

apply for an exemption according to section 2 para 4 GBA if the company is

supervised utilizing international accounting standards in the home country and the

responsible authority works together with the BaFin According to section 53b

GBA companies of EEA states are allowed to establish branches (section 53b para

2) but are also free to conduct cross-border financial services without a domestic

presence (section 53b para 2a) Section 32 para 1 GBA does not apply to business

that is motivated by the initiative of the domestic individual or enterprise (so called

passive service freedom)

Representations are limited to their representative function and are not allowed to

conduct or initiate any banking business

Capital requirements are low for cross-border lending and and relatively low for

representations With high equity modes such as branches and even more so with

subsidiaries capital requirements are relatively high as capital is required for

building a broad network of facilities and offering credit to customers Capital

requirements for direct banks are relatively low compared with those of BampM

banks

The necessity of large scale operation is related to the competitive advantage of

economies of scale A company that serves the market in the context of larger

quantities benefits from lower cost per unit In retail banking profit is gained by

having a large number of clients It is expensive to build up these numbers and to

establish a distribution network to serve them This necessity relates directly to the

strategy of the bank An acquisition offers a shortcut to these facilities although the

25

costs of integration can be high as well74 A MNB may also decide to target only a

certain geographical area with certain clients and therefore do not have to enter on

a very large scale

Customer switching costs are different for each individual In general customers

can easily change their banks and open a deposit account or apply for a loan at

another bank However they have to compare the different terms for usually small

transactions to evaluate the convenience of having a bank nearby and then to

decide to terminate the relationships with their current bank75

Finally the incumbency advantages of existing banks are important entry barriers

In particular they include established brand reputation possession of the most

favorable geographical locations and market knowledge Moreover established

banks may already have exclusive contracts with SMEs76

To conclude legal entry barriers are low and particularly low for banks from the

EEA Capital requirements for entering the market are high yet as far as equity

entry modes are concerned direct banks require relatively low capital as they

distribute their services through low-cost channels Banks need to attract many

customers to be profitable but banks strategy dictates whether or not to entrance

should occur on a large scale Moreover the incumbency advantages of existing

banks constitute important entry barriers

44 Threat of Substitute Products or Services

A substitute in retail banking is a service that offers an attractive trade-off to a bank

service or product As individuals and small firms do not regularly report financial

information as do large enterprises they rely primarily on bank lending However

there are additional forms of financing in the private equity or dept market77

Many non- and near- banks provide substitute products and services Near-banks or

quasi-banks are suppliers of financial services but are not classified as credit

institutes according to section 1 GBA Near-banks such as insurance companies or

credit card organizations however do provide substitute products or services Non-

74 Hughes and MacDonald (2009) 75 Adams (2002) 76 Adams (2002) 77 Xiaoqin and Terada-Hagiwara (2003)

26

banks such as department store chains catalog companies or car producers also

provide substitute services78 For instance instead of taking out a loan in order to

pay for a product individuals or small enterprises may decide to take on a leasing

contract for a certain asset or small enterprises can obtain a trade credit as well

Individuals may decide on buying products from insurance companies instead of

putting money into a bank account

Another substitute for both direct and BampM banks is the person-to-person (p2p)

lending business a new form of borrowing and lending money that takes place in a

web-based market place In this online platform borrowers are connected to

lenders through an auction-like process in which a lender who bids to provide a

loan for the lowest interest rate will be awarded the loan contract with the

borrower A p2p company mediates between private or company borrowers and

lenders and also executes transactions between the parties similar to the role which

e-bay plays in the trade of commercial goods79 The p2p lending business does not

involve traditional banks and thus can offer superior interest rates to borrowers and

higher returns for lenders

45 Bargaining Power of Suppliers

When a supplier group is more concentrated than the industry does not primarily

depend on the industry and when the industry faces high switching costs the

supplier group has strong bargaining power and can reduce the profit potential of

an industry In the retail banking market the most relevant suppliers include human

resources suppliers of capital resources and suppliers of information and

communication technology (ICT)80 Highly talented or experienced specialists are

strongly canvassed and have strong bargaining power with respect to their salary

and working conditions However in the aftermath of the financial crisis many

banks are planning a reduction of staff According to a study of Ernst amp Young

every fifth bank intends to decrease staff and only every 10th bank is planning an

increase81 Given the current situation of the employment market the bargaining

power of employees is relatively low Suppliers of highly specialized banking ICT

78 Gabler Wirtschaftslexikon (2010) 79 Deloitte (2009) p 12 80 Buumlschgen and Boumlrner (2003) 81 Ernst amp Young (2009)

27

solutions have strong bargaining power as switching costs for these systems are

very high Moreover the higher yield requirements of shareholders can be

interpreted as supplier power

46 Bargaining Power of Buyers

In retail banking there are many buyers with relatively low transaction volumes

which weakens their bargaining power However retail banking services are

standardized and buyers can easily find similar services Switching costs have

usually been relatively high for these low volume transactions but in the age of the

internet the market is very transparent and buyers can screen different offerings

more easily This does not necessarily imply that the cheapest banking service will

be chosen automatically as customers also seek a trustworthy brand especially in

times of financial crisis Moreover there are other factors that affect the switching

cost of the individual such as the location of the branch Yet there is a tendency

towards the increasing bargaining power of buyers

This is also substantiated by the ZEW survey 7984 of market experts state that

decreasing customer loyalty and increasing price sensibility are important or very

important factors with respect to the intensity of competition in the German retail

banking sector A comparison of former and modern retail customers also indicates

that the bargaining power of retail banking service users has increased

Former Retail Customer Modern Retail Customer

Passive information seeking

behavior

Active information seeking behavior

Hardy or little informed Good to very good know-how

High customer loyality Increasing willingness to switch

Fixation on the branch Expects multi-channel banking at all times

and places

Little market transparency High price transparency

Relatively undemanding Demanding

Figure 9 Comparison of former and modern retail customers (own illustration based on Swoboda 2004)

28

5 Foreign Bank Entry Strategies in Germany

This section illustrates mode choices for foreign bank entry in Germany Based on

the hierarchical model of market entry modes82 the foreign bank has the choice of

equity and non ndash equity modes of entry An advantage of the hierarchical model is

that it allows comparing between entry modes on different levels The main

difference between equity and non ndash equity modes is the degree of resource

commitment in the foreign country As classified at the beginning of this thesis

non-equity entry refers to international banking and equity entry refers to

multinational banking

The research question of this thesis considers multinational bank entry modes

International banking however is often a first step towards multinational banking

Hence this thesis will also discuss cross-border lending and alliances as non ndash

equity entry modes The following figure illustrates a comprehensive view of

market entry modes for banks

Figure 10 A hierarchical model of entry mode choices for banks (own illustration based on Pan and Tse 2000)

82 Pan and Tse (2000)

Entry Mode Choices

Non - Equity Modes

Export

Cross Border Lending

Contractual Agreements

Alliances

Equity Modes

Equity Joint Ventures

Greenfield Investment

Branch

Subsidiary

Representation

Acquisition

Subsidiary

Branch

29

The hierarchical model illustrates the various entry mode choices for entering the

German retail banking market The creation of a common European financial

market in which banks can integrate freely is a major goal of the European Union83

The previous section of this paper indicates that entry barriers are relatively low

and that the German market is highly competitive Hence the choice of a proper

entry mode which is appropriate to the capabilities and the strategy of the bank is

even more significant Therefore the following section will reflect on the strategic

concept governing the choice of entry modes as well as the proliferation of these

entry modes in the German retail banking market

An international bank that is not interested in investing equity in the foreign

market can enter by means of cross-border lending or by forming a non-equity

alliance These non-equity entry modes can help the bank to access niche markets

or to exploit locational advantages when the bank is located near the German

border

However a retail bank defined in the beginning of this paper as a bank that

`caters for ordinary individuals and small businessacute and that seeks to enter the

German market in order to gain significant revenue from deposits and loan

business might have to consider a physical presence in the foreign country

The analysis considers entry modes that are perceived as international banking

cross-border lending and non-equity strategic alliances Furthermore the equity

modes JVs and representations will be discussed

Subsequently this section compares the market entry of a branch through

Greenfield investment with the market entry of a subsidiary by virtue of

acquisition as these modes of entry are the most common in the German retail

banking market

Finally the following question will be addressed to what extent do demographic

and technical trends favor a direct bank entry mode over a brick and mortar bank

approach in Germany

83 Fidrmuc and Hainz (2008)

30

Figure 11 Greenfield vs acquisition and BampM banks vs direct banks (own illustration)

51 Non ndash equity modes Export ndash Cross-Border Lending

Cross-border lending is equivalent to the export entry mode and is a simple non-

equity strategy to enter a foreign market A bank which participates in cross-

border lending must assess the creditworthiness of the individual borrower as well

as the country risk which involves the possibility that these loans will be impaired

by economic or political proceedings in the foreign country84 The country risk in

Germany is rather low as it is perceived to have a solid political and economic

situation (Country Rating A2) with a stable and a very efficient business

environment (Country Rating A1)85 As a bank will only have limited access to soft

information about the creditworthiness of the borrower the availability of loans

usually decreases and the interest on loans usually increases with distance86 Soft

information for private loans includes the previous experience with the account

management of the credit user environmental facts and a judgment relative to his

employment contract87 For corporate loans soft facts may include the market

environment corporate structure management a business plan as well as

84 Hughes and McDonald (2003) 85 Online wwwtrade-safelycom (2009) 86 Agrawal and Hauswald (2007) 87 Dizil (2009)

Entry Mode Choices of MNBs

Greenfield Investment

Branch

Brick and Mortar Bank Direct Bank

Acquisition

Subsidiary

Brick and Mortar Bank Direct Bank